Industrials: Market Pullback Provides More Investment Opportunities

Amid growing concerns about slowing US growth, exacerbated by the Trump administration’s fluid global trade policy, the Morningstar US Industrials Index has underperformed the broader market since Election Day, as investors have reduced exposure to cyclical companies.

Even so, industrial stocks with defensive characteristics, such as waste management and some businesses services, have performed well. That’s because relative to the sector, these firms enjoy stable cash flow throughout the business cycle and tend to have good pricing power. For example, the waste management industry realized record pricing gains and profit margins over the past three years, even as inflation reached levels last seen in the 1980s.

Defense contractors generally enjoy long-term revenue visibility and carve out economic moats via intangible assets and switching costs. Furthermore, we don’t think that tariffs pose much of a risk to this industry. Even so, defense contractor stocks have underperformed since the election, likely due to heightened concerns about defense budget cuts. But we believe budget discussions among the executive and legislative branches of government are normal annual events, meant to free up funds for high-priority programs. We see compelling opportunities in this space, and most of the defense-oriented stocks we cover are undervalued.

Many industrial firms have incorporated digital technologies into their product refreshes. In our view, these enhancements can not only improve product performance but also expand service opportunities and therefore damp cyclicality for equipment manufacturers. Notably, we think precision agriculture technology will expand the addressable market and boost profit margins.

Uncertain global trade policy has caused consternation among investors. However, much of our industrials coverage have mitigation plans in place. For one, many firms have significantly reduced supply chain exposure to China in response to serious disruptions during the covid-19 pandemic and trade policies during the first Trump administration. Over the near term, we’d expect industrial firms to mitigate tariff costs through price increases and cost-cutting initiatives, while reshoring supply chains would be a longer-term response, should tariffs persist.

Top Industrials Sector Picks

CNH Industrial

CNH Industrial CNH is a global manufacturer of agricultural and construction equipment. The firm’s next strategic chapter is the advent of “precision agriculture,” meaning the incorporation of various digital technologies into agricultural equipment to enhance crop yields and drive other efficiencies. Incorporating these advanced technologies into its products and working closely with its network of customers ideally sets CNH up in a virtual circle of margin-accretive innovation in a growing global market.

Northrop Grumman

Northrop Grumman NOC is a diversified defense contractor providing aeronautics, defense, and space systems. We think Northrop has a distinct portfolio of capabilities that positions it well to serve current and future needs of the US and allied militaries (as well as a penchant for advanced space exploration technology), which are often spurred by the need to deter or outpace a specific military rival. The three biggest growth opportunities we see for Northrop are the continued development and manufacture of the B-21 bomber, the Sentinel weapon system, and the further militarization of space.

Fluor

Fluor FLR is one of the largest global engineering and construction firms, and its integrated solutions capability differentiates it from many rivals. Following a strategic review of its portfolio, the company has significantly lowered its fixed-price exposure, as reimbursable contracts now account for 80% of the backlog. We believe that reducing its fixed-price exposure will help derisk Fluor’s backlog and lower the risk of material value destruction due to cost overruns. Furthermore, we think the market underappreciates the upside potential from Fluor’s investment in NuScale, which developed a small modular reactor technology.