When inflation is on the rise, industrial stocks stand to benefit—within the sector, five stocks look fairly promising if inflation increases as much as markets are signaling lately.
Inflation expectations have popped since the end of September, which marked a renewed shift for investors into economically-sensitive assets and out of safer ones. Market-based inflation expectations for the next decade, according to data from the St. Louis Federal Reserve, have risen to almost 2.2%, from roughly 1.6% at the end of September. In that time, yields on long-dated Treasuries have more than doubled in response.
Of course, there is the argument that higher yields make stocks less attractive against haven bonds, and can reduce equity valuations. But industrial stocks, however, have participated in the recent rally—mostly because they should see rising near-term sales and earnings with a strengthening economy. The Industrial Select Sector SPDR Fund (ticker: XLI) has risen almost 23% since the end of September, beating the S&P 500’s 19% gain.
Most strategists say now is the time to move toward cyclical assets, which tend to be riskier. One way to gauge a stock’s risk level is by looking at its volatility—and for those who can stomach the risk in exchange for high returns, it could be a case of the more volatility, the better.
Barron’s recently noted that the industrials sector is the third most-sensitive to changes in interest rates, out of the more than 10 sectors in the S&P 500.
Here are the five industrial stocks that are most sensitive to changes in interest rates—and, in turn, should benefit from a recovering economy—according to strategists at Evercore.
Fortive stock (ticker: FTV) has an 84% correlation with the 10-year Treasury yield. Simply put, that means when the 10-year’s yield rises and falls, Fortive shares rise and fall almost in lockstep. Fortive makes industrial technologies and engineered products and should benefit from stronger industrial demand.
The stock is only up 11% since Sept. 23, underperforming the S&P 500. In the past year, it has been 17% more volatile than the S&P 500, according to FactSet data—but that is actually a relatively low volatility level compared with many industrial stocks. With cyclical companies, their earnings typically vary more in response to rising or falling economic activity, often resulting in more volatility for the stock.
Aerospace giant Boeing (BA) is second on Evercore’s list, with a 72% correlation with the 10-year Treasury yield. The stock is up 45% since Sept. 23. It has been more than twice as volatile than the S&P 500, partly because it supplies the airline industry, which has been decimated by the pandemic. However, an eventual pickup in air travel should be good news for Boeing, which saw its orders and deliveries stall during the pandemic and after its 737 MAX was grounded in 2019.
Idex (IEX), with a $15 billion market cap, is 63% correlated with the 10-year note, and has been marginally less volatile than the broader market in the past year. That is not a huge surprise: A third of its revenue now comes from health and science technologies customers, a customer base whose needs are less tied to the ebbs and flows of the broader economy. The stock is up 12% since Sept. 23.
Diversified industrial giant Emerson Electric (EMR) has a 58% correlation with the 10-year yield, and has been only slightly more volatile than the market. Emerson sells products into dozens of cyclical end markets hammered by Covid-19. Higher energy prices is great for oil-producing customers. More construction activity means more tools sold. And factories bringing back workers turns into sales for its automation and control systems.
Textron stock (TXT) is 57% correlated with the 10-year Treasury, is up 50% in the same span, and is 65% more volatile than the market. The company makes aircraft and helicopter components.
One caution area for S&P 500 industrials, however, is that they lean a bit pricier. They trade at a forward earnings multiple 12% higher than that of the average stock on the index.
Write to Jacob Sonenshine at [email protected]