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The Challenges Ahead for Industrial ETFs

This article was originally published on ETFTrends.com.

The Industrial Select Sector SPDR (XLI) , the largest ETF tracking industrial stocks, is down about 3% year-to-date. Some market observers believe the once sturdy industrial sectors faces more near-term headwinds.

XLI “seeks to provide  precise exposure to  companies in the following industries: aerospace and defense; industrial conglomerates; marine; transportation infrastructure; machinery; road and rail; air freight and logistics; commercial services and supplies; professional services; electrical equipment; construction and engineering; trading companies and distributors; airlines; and building products,” according to State Street.

Some big-name industrial stocks have been slammed on fears of an escalating trade war between the U.S. and China, the world’s two largest economies. In early April, shares of Dow component Boeing slipped after China announced a 25% tariff on airplanes in response to proposed tariffs by President Donald Trump’s administration on $50 billion worth of imports, including medicines, chemicals and consumer electronics.

“Goldman Sachs' Jerry Revich removed Caterpillar (CAT) and Deere (DE) from the firm's Conviction Buy List Tuesday (although he retained Buy ratings on both stocks), and he also downgraded Manitowoc (MTW) and Generac Holdings (GNRC) to Sell from Neutral, with new, lower price targets of $22 and $45, respectively,” reports Teresa Rivas for Barron's.

Caterpillar and Deere are among the marquee names found on XLI's roster.

Tariff Uncertainty

The ongoing uncertainty over the Trump administration’s trade policy threatens to slow corporate spending and drive up costs, which could weigh heavily on the industrial sector, with the tariff-sensitive S&P 500 industrial sectors continuing to underperform the broader market.

Related: Trump’s Ongoing Trade Tiff Threatens to Slow Industrial ETFs

“Revich believes we're approaching an 'above-normalized share of capital expenditure' in a number of areas for machinery makers, and argues that investors have to be selective in the sector,” according to Barron's. “He prefers to focus on companies with end markets with low capital stock, like mining and agriculture, as well as those with improving returns on capital and competitive moats.”

Traders could also hedge against further risk in the industrials sector through bearish ETF plays like the ProShares UltraShort Industrials (SIJ) , which tracks the inverse 2x or -200% daily performance of the Dow Jones U.S. Industrials Index. SIJ jumped 6.6% over the past week as XLI dipped 3.9%.

For more information on the industrials sector, visit our industrials category.