Can Cyclical be weeded out from Secular Industrial growth?
A booming copper price signals a strong economy, this time largely driven by secular factors. Here we try to weed out the plain-vanilla cyclicals from the secular growth driven industry stocks.
Investing in industrial stocks only makes sense if you are bullish on GDP and Industrial Production. If you're not, avoiding them is straightforward. But today there more to it than this narrow cyclical view.
The Mag 7 and Big Tech have been all the rage lately, and rightly so. Tech plays a crucial role for the global economy. But it cannot do it alone (not yet at least). Technology has come to rely heavily, and be closely intertwined with the Industrial sector.
Today, a lot of industrial activity is not longer about blast furnaces and brute force, but more about clean rooms, precision engineering, deep logic and hyper-precision.
Despite digital advancements, physical infrastructure remains essential. We need modern factories, efficient supply chains, and robust infrastructure to support the digital world. Moreover, as we move forward, environmentally sustainable methods are becoming increasingly important.
While it might seem straightforward to choose an industrial ETF, there are significant nuances when it comes to cyclical and secular growth components between different ETFs. With a sector, top-down approach, these can be difficult to unbundle. But here we're going to make a try.
Standard XLI vs Momentum PRN
The premier industrial sector ETF, the SPDR Industrial Select Sector ETF (XLI), for example, includes companies outside traditional manufacturing, like transportation firms, which make up a significant portion of its portfolio. While these firms are important, they don’t align with the secular growth theme that we're now trying to get exposure to.
Instead, we look at the Invesco Dorsey Wright Industrials Momentum ETF (PRN). Although technically a passive fund, PRN tracks an index designed for superior outcomes using a momentum model that considers stock price strength over various periods.
Momentum can be risky on its own, as it might lead to investing in a hot area just as it’s about to decline. However, when combined with other factors, it can be a powerful indicator that the market favors certain stocks. This added support has given PRN a notable edge over XLI.
Momentum Score and composition
Looking only at price action, it's clear that PRN has done markedly better in 2024 than the XLI. However, short interest is rising in PRN constituents, Net Buy/Sell recommendations from sell-side analysts have turned negative in the past 3 months, as has insider activity. Other indicators such as long term price trend and strength look better while constituents' volatility have come down.
As for XLI we note significant pick-up in insider activity, most notably insider purchases in RTX Corporation (former Raytheon, which is not surprising given the increased geopolitical uncertainty over the past year), and legacy industrial giants Honeywell and Caterpillar.
Cannot escape cyclicality
Despite this careful selection, it’s essential to acknowledge the cyclical nature of the industrial sector. Even with a focus on secular growth, industrial companies are not entirely immune to economic fluctuations. If sectors like semiconductors and software feel the impact of reduced corporate spending, so too can secular industrial firms.
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