For the last few weeks, we’ve been reviewing the merits of defensive sectors in a recession-resistant portfolio. We’ve already mentioned Consumer Staples, with stocks like Kellogg’s, Costco, and Conagra. Now, we’re moving onto Industrials, another “boring” sector set up for technical and fundamental outperformance.

Are Industrials "Recession Proof"? It Depends.

Industrial development is economically significant. And given today's conditions, it could relieve the supply-side pressure partly responsible for today's inflation and negative GDP.

A central bank might make money from nothing, but it can’t do the same for physical goods – this fact alone is responsible for inflation globally. The pressure comes almost entirely from the supply-side. Investors are neutral about Industrials relative to other sectors as it trades near historical P/Es, but this is way below the January 2021 peak, when the sector traded at nearly 53x earnings.

Annual PE Growth Rates, Industrials Sub-Sectors (Consensus)Source: Bloomberg

More downside isn’t impossible, but given rebalancing has favored Industrials we may be nearing a bottom.

Looking forward, analysts are most optimistic about airlines, expecting annual earnings growth of 35% over the next 5 years – unsurprising, given the travel rebound has pushed some international airports to their limit.  

While airlines have been stubbornly troublesome investments, related names like Boeing ($BA) have fared better as the company delivered the most orders since 1Q2019 with  relative outperformance. With airline fleet renewals and net orders surpassing cancellations, the future looks a little bit brighter. But Airbus did much better, dropping only 25% this year, compared to 55% for Boeing.

Meanwhile, Basic Materials look like a better deal, trading at an average 12.6x earnings, far below the 10-year average of 17x. This sector has also outperformed the market in the last year by almost 5%.

YTD Performance SPY vx. XLB vs. XLISource: Tradingview

Investors are bullish on the Packaging sub-sector too, which has seen a significant decline of 20% this year. Packaging Corporation of America ($PKG) is among the prominent candidates to add to the watchlist, as it trades at a reasonable 13.8x P/E and 1.6x P/S ratio. The company will report Q2 earnings results on July 25.

Wall Street, meanwhile, has its eye on Basic Materials, anticipating an annual earnings growth of 19% over the next 5 years.

Other sub-industries like Forestry could be important to watch as we head deeper into a recession and a likely negative 2Q22 GDP print later this week. Although the equity analyst consensus for forestry products is poor, we believe there is hidden upside. Alternative investments like timber and infrastructure, which are historically more recession-resistant than fixed income or equity securities, could become strong value investments in the coming months. Look for our deeper analysis over the next few days.

Only Degenerates, Tendies, and its analysts have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

Jul 26, 2022
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