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Manufacturing 9-Month Low: Are Industrial ETFs in Trouble?

Sanghamitra Saha
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The U.S. manufacturing sector continued to slow in April 2018 from the preceding month. Per trading economics, Supply Management’s Manufacturing PMI in the United States dropped to 57.3 in April from 59.3 in March and falling shy of market expectations of 58.3.

The reading marked the feeblest rate of growth since last July, thanks to trade war fears and rising prices. The situation was the same in March when PMI dropped from February’s 14-year high of 60.8, and missed market expectations of 60.1.

What Caused Slowdown

Four out of six main components registered sequential declines. The production index fell 3.8 points to 57.2% while employment slipped 3.1 points to 54.2%, marking the lowest level in about a year.

Trump’s imposition of tariffs on steel and aluminum is a major concern across the supply chain. Notably, Trump announced a 25% tariff on steel imports and 10% for aluminum in early March (read: 6 Top ETF Stories of Q1).

Last month, industry players indicated that the tariff announcement resulted in panic buying, which in turn raised near-term prices and caused a decline in inventories for non-contract customers. Also, steady economic growth resulted in rising prices. This is especially true given that wages rose at their fastest clip in 11 years in the first quarter.

The Prices Index is hovering at its highest level since April 2011. However, overall, demand stayed steady as evident from the New Orders Index at 60 or above for 12 consecutive months.

Raw materials prices have been rising for 26 months in a row. Apart from the price rise and tariff tantrums, lead time extensions, shortages of workers and transportation glitches led to the slowdown.

Trump Acting as Both Rescuer and Destroyer

Trump bump was the wind under the wings of the industrial rally in 2017. S&P 500 Industrial Sector SPDR XLI gained about 20% last year on the tax reform and Trump’s proposed infrastructure spending worth $1 trillion dollar. Increased outlays were aimed at improving roads, bridges and telecommunications. The President also promised easing regulations.

However, this year, the fund is down 1.4% despite the passing of the tax reform in late 2017. Ongoing worries regarding the U.S.-China import tariffs are acting as a major setback for the sector (read: Industrial ETFs at All-Time Highs: Any Value Left for 2018?).

Rising Rate Worries

Plus, since the start of 2018, rising rate worries are rife thanks to higher inflationary expectations. The U.S. benchmark Treasury yield crossed the level of 3% in April. The Fed already enacted a hike in March and is forecast to enact two more in 2018.

However, many market watchers are expecting four rate hikes this year. If this happens, borrowing costs will tick up, hurting manufacturers’ profitability. Also, the greenback will gain strength, which could leave a negative impact on exports (read: Win From Rising Rates With These 4 ETF Strategies).

Rising Energy Costs

The oil patch is also stabilizing with rising prices. WTI crude fund United States Oil Fund LP USO is up about 9% this year on chances of an extension in the OPEC output cut deal and geopolitical crisis.  Since the manufacturing sector needs to consume energy for production, the latest rise in oil price may dent industrial stocks (read: Top Performing Energy ETFs of 2018).

ETFs in Focus

Against this backdrop, investors may stay on the sidelines when it comes to playing industrial ETFs. Gutsy investors may bet on a particular corner of the industrial sector – Aerospace and Defense – with ETFs like PowerShares Aerospace & Defense PPA, iShares U.S. Aerospace & Defense ETF ITA and SPDR S&P Aerospace & Defense ETF XAR.

The sector belongs to a top-ranked Zacks industry (top 6%). These funds are among the outperformers in the space this year. PPA, ITA and XAR have added about 5.4%, 5.5% and 4.1%, respectively, so far (read: Top and Flop Sectors of Q1 and Their Wining & Losing Stocks).

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US-OIL FUND LP (USO): ETF Research Reports
 
SPDR-INDU SELS (XLI): ETF Research Reports
 
ISHARS-US AEROS (ITA): ETF Research Reports
 
SPDR-SP AER&DEF (XAR): ETF Research Reports
 
PWRSH-AERO&DEF (PPA): ETF Research Reports
 
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