A Muddled Outlook For Industrial ETFs

The Industrial Select Sector SPDR (NYSE:XLI), the largest exchange traded fund devoted to the industrial sector, is up 4.6 percent year-to-date. That is a middling performance among the sector SPDR ETFs, but definitely an improvement over the 4.3 percent the ETF lost last year.

Recent U.S. factory data falls in the good-but-not-great category and as Caterpillar Inc. (NYSE:CAT) showed on Thursday, betting on big-time earnings beats by XLI constituents probably is not something investors should bet on.

Dow component Caterpillar, the maker of construction and mining equipment, forecast a first-quarter profit of 50 cents to 55 cents a share on sales of $9.3 billion to $9.4 billion. For the full year, Caterpillar expects to earn $4 a share, excluding costs, on revenue of $40 billion to $44 billion, according to InvestorPlace.

Caterpillar is XLI's 10th-largest holding at a weight of almost 2.5 percent.

The industrial sector as a whole is therefore on course for a flat first quarter. When combined with the mere 0.2% rise signalled for recent core retail sales data, the industrial malaise adds to suggestions that the pace of economic growth could disappoint in the first quarter compared to widespread expectations among analysts of 2-2.5% annualised growth, said Markit in a recent note.

Components

In addition to Caterpillar, XLI is home to four other Dow components: General Electric Company (NYSE:GE), 3M Co. (NYSE:MMM), Boeing Co. (NYSE:BA) and United Technologies (NYSE:UTX). Caterpillar, General Electric, 3M and United Technologies are four of the 18 Dow stocks that have traded higher year-to-date. Conversely, Boeing is one of just eight Dow stocks down at least 5 percent year-to-date.

Slumping oil prices are problematic for some of XLI's holdings, including GE, because these companies count oil services firms as well as exploration and production companies among their energy sector clients. But the case for industrials is not all bad.

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 weve quietly reached the mid-point, said State Street's Michael Arone in a recent note.