- Supply chain issues, wars, and geopolitical risks have all weighed on recent performance, but could be the catalysts needed to drive demand into the future.
- Businesses and governments are looking at ways to build domestic capabilities, offering the construction sector plenty of opportunity. There’s also an opportunity in data analytics.
- Recession risk could impact short-term performance, but growth drivers likely remain in play over the medium term.
The industrials sector is a broad category of stocks that includes companies involved in manufacturing goods, so think machinery, tools, and heavy vehicles. There are also construction and engineering businesses as well as those involved in transportation and even data analytics.
It tends to be a cyclical sector, meaning performance is tied to the economy's overall health. Though, it’s less sensitive than the likes of consumer cyclicals and basic materials and past performance isn’t a guide to the future.
How has the industrials sector performed?
Over a five-year time horizon, the global industrials sector has underperformed the broader market by just shy of 8%*. Given the timeframe, that's a relatively small difference and highlights the sector's cyclical nature.
As you might have expected, the sector suffered from many of the same challenges that loomed over the broader market. The pandemic fueled fears that global growth would slow, supply chains were in meltdown, and there was uncertainty about what demand would look like when we came out the other side.
Total Return of Industrials Sector vs Global Equity Index
Source: *Refinitiv Eikon, 31/05/2023 (Industrials Sector = Refinitiv Global Industrials Index, Global Equity Index = FTSE Global All Cap Index).
More recently, higher inflation, the war in Ukraine, and repeated lockdowns in China weighed on the outlook for global economic growth – keeping a lid on the post-pandemic run-up.
What's next for industrials in 2023?
Looking ahead to the rest of the year, challenges remain.
The Chinese reopening hasn't been the huge boost to global economic activity that some thought it would be. However, the International Monetary Fund still expects it to be the biggest single driver of global growth this year.
Manufacturing data is trending weaker too. We've seen the US Manufacturing PMI, a leading indicator of economic activity, sit below pre-pandemic levels in recent periods – mainly due to lower demand.
But it's not all doom and gloom, and we see pockets of more positive news. Supply chain pressures look to be easing, and there are signs that input costs are starting to ease.
Putting on a long-term hat, there are still a few key drivers of growth we see as offering potential moving forward.
Moving manufacturing closer to home
The past few years have shone a huge spotlight on some of the vulnerabilities that come with relying on other countries for critical goods and services. Pandemic-related supply chain impacts, rising tensions between China and the West, and Europe's reliance on Russian energy are a few examples.
Global trade has been the key to offering low prices for a long time. But national security and economic resilience are becoming bigger parts of the discussion. The silver lining for the industrial sector is that governments are now looking to bolster domestic manufacturing and onshore supply chains, creating opportunities.
The US is a great example, where several government bills and billions of dollars have been pledged to supporting infrastructure and the onshoring of manufacturing. Some of the largest names in the infrastructure sector helped lobby for these bills. This increased government spending on critical infrastructure should drive demand for manufacturing equipment and labour over the coming years.
There's also the potential benefit from businesses looking to shore up supply chains following the disruption seen during the pandemic. The auto industry is a perfect example, where the lack of key chips meant demand couldn't be met. We'd expect to see an increase in the number of manufacturing facilities built in areas like the US and Canada – another demand driver for industrials.
The shift to sustainability
Hitting sustainability targets at a corporate and government level will take some heavy lifting to achieve. The switch to low-carbon energy sources requires new technologies and infrastructure. There are plenty of opportunities for the cohort of industrial businesses with exposure to energy storage and transportation, or those able to help build out low-carbon infrastructure.
Electric vehicle charging is an obvious example. At the end of 2022, there were 2.7 million public charging stations across the globe. That was 55% higher than the previous year.
In the UK alone, the government unveiled a £1.6bn spending program last year to build out 300,000 charging points by 2030.
The widespread adoption of electric vehicles can only be sustained if charging demand is met. That requires home/public charging and a huge infrastructure buildout to get there.
The power of data
It might seem odd to talk about data analytics businesses alongside construction and infrastructure, but the sector is broad and does contain names that have a more software-focused business model. We see a particular opportunity for those who produce software to help with things like credit and risk analysis.
As artificial intelligence (AI) and machine learning evolve, the power of data analytics only gets stronger. Data can be analysed in more ways to help customers gain better insight into a range of behaviours and trends.
In this space, we particularly like those with large amounts of proprietary data – the real key to delivering a differentiated product is having data for models to learn from that no one else has access to.
Our view on the industrial sector
Following a difficult period, we see several growth drivers for the industrial sector. Onshoring of supply chains, increased government spending on infrastructure, and an energy transition should all be demand drivers over the medium term for the more construction-heavy names.
Persistent high inflation, rising interest rates, and the increased chance of recession are the biggest risks for the sector over the short term. A hard landing with prolonged economic trouble would no doubt impact earnings and delay some of the sector's growth drivers – though we don't think it would derail them.
We generally prefer larger names in the more traditional industrial space. They tend to be better able to weather storms and have more pricing power to help protect margins in uncertain times. We also see an opportunity in data analytics, to use newer technology and leverage proprietary data sets.
As always, remember investments and any income from them can fall as well as rise in value so you could get back less than you invest. This isn’t personal advice – if you’re not sure what’s right for you, ask for advice.
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