It Might Finally Be Time For Industrial ETFs

Industrial stocks and exchange traded funds have been duds. Over the past year, the Industrial Select Sector SPDR XLI, the largest industrial ETF is down 9.3 percent, a loss that is more than double that of the S&P 500 over the same period.

For the six-year period ending 2015, XLI outperformed the S&P 500 just twice. Over the past year, 11 members of the Dow Jones Industrial Average are off at least 10 percent. Three are marquee members of XLI's lineup: Boeing Co. BA, Caterpillar Inc. CAT and United Technologies Corp. UTX.

“The shale oil & gas revolution is contributing to a manufacturing renaissance that has resulted in rising margins and faster long-term EPS growth. However, revenues could be down this year due to the strong USD and the soft economy, evident in the negative estimate revisions. However, the sector's P/E multiple has held fairly steady even as the market's P/E has risen, boosting Industrials' attractiveness to slightly above that of the S&P 500,” according to AltaVista Research.

Even with the aforementioned challenges in mind, the timing could be right to consider industrial stocks and XLI.

“The industrials sector has historically performed well in the middle of the economic cycle and underperforms in recessions. The mid-point of the economic cycle is defined by slowing profits and rising rates. US corporate profits peaked since the financial crisis and have been decelerating for the last couple of quarters, while the Fed raised rates in December. Despite a hardly noticeable early cycle phase, the long economic cycle is aging and we’ve quietly reached the mid-point,” said State Street's Michael Arone in a recent note.

The $5.4 billion XLI holds 68 stocks with its largest holding being an 11.6 percent allocation to Dow component General Electric Co. GE.

AltaVista rates XLI at Neutral, which “indicates that valuations adequately reflect the fundamentals of stocks in these funds,” according to the research firm.

There are other catalysts that could help XLI cobble together some momentum.

“Industrials will be the primary beneficiaries of increased government spending and a flattening US dollar. I believe that that many of the benefits are being underestimated by investors, which is a big reason why I have conviction on industrials. At the same time, easy year-over-year comparables should lead to upside revenue and earnings-per-share surprises for the sector,” adds Arone.