What Can Help Industrial ETFs

With the Industrial Select Sector SPDR (NYSE:XLI) up nearly 12 percent year-to-date, it's hard to say the industrial sector is struggling. XLI's performance is good for the fourth-best among the nine original sector SPDR exchange traded funds.

However, much of the upside being accrued by XLI and rival cap-weighted industrial sector ETFs is being driven by aerospace and defense stocks. That group is XLI's largest industry weight at 27.2 percent, or nearly 1,000 basis points more than the ETF's second-largest industry weight.

While some industries and sectors have been pinched by election year rhetoric, markets seem to be pricing that regardless of the winner of the presidential race, Democrat Hillary Clinton or Republican Donald Trump, the outcome will be favorable for aerospace and defense names.

Meanwhile, some of the industry weights within XLI, including airlines, diversified conglomerates and railroad operators are not keeping up their end of the industrial ETF bargain. Still low commodities prices are weighing on diversified conglomerates.

Most diversified industrials and capital good companies reported sales declines in the second quarter although the pace of decline moderated for some companies due to easier year-over-year comparisons. Lower sales reflect the impact of depressed commodity prices, weakness in emerging markets and the strength of the dollar. Sales declines are widespread and have been ongoing for some time, evidenced by a downward trend in industrial production since the second half of 2014, said Fitch Ratings in a recent note.

Some diversified industrial conglomerates, such as Dow component General Electric Company (NYSE:GE), have exposure to the oil services industry, indicating some of level of sensitivity to crude prices. Other end markets are also crimping demand for industrial products.

Companies selling into commodity-driven end markets such as oil and gas, mining and agricultural equipment have been the most affected. The heavy duty truck sector is also down sharply in 2016 as the industry adjusts to weak freight volumes. In contrast, the automotive, aerospace and US construction industries have continued to perform well, though low growth in emerging regions is negatively affecting demand for construction equipment, adds Fitch.

GE is XLI's largest holding a 11 percent of the ETF's weight. XLI, the largest industrial ETF, also features three other Dow components among its top 10 holdings, 3M Co. (NYSE:MMM), United Technologies Inc. (NYSE:UTX) and Boeing Co. (NYSE:BA).