The S&P 500's latest attempt to dig out from the depths of the bear market has been built with a whole lot of muscle and metal. S&P 500 industrial stocks like Caterpillar (CAT) and Freeport-McMoRan (FCX) are key players. Just since the end of Q3, Caterpillar stock has carved out a 55% gain. Freeport-McMoRan shares have rallied an electrifying 65%.
XBoth earthmoving heavy-equipment giant Caterpillar and copper miner Freeport-McMoRan are economic bellwethers. The performance of CAT stock and FCX reflect broad strength across their industry groups and related fields that are the workhorses of the global economy.
Other materials and industrial stocks to watch include United Rentals (URI), Terex (TEX), Rio Tinto (RIO), BHP Group (BHP) and Deere (DE). All have shown constructive recent chart action, positioning the stocks for potential new uptrends.
What is driving that strength amid the drumbeat of projections for global recession? The groups' recent outperformance doesn't preclude a rocky road ahead, or even an economic downturn. But it does signal that the stock market has entered a period in which the workhorses of the industrial economy could lead the field, potentially for years to come.
Forces reshaping the global economy include Covid, U.S.-China tensions, Russia's invasion of Ukraine and climate change. These trends have set the stage for accelerated investment in mining, manufacturing and infrastructure.
And investment is getting a massive push from three big legislative packages approved under President Joe Biden that could plow $1 trillion into earthmoving projects over a decade. Even if the U.S. and global economies tip into recession, the big-spending pipeline will keep flowing. For these segments of S&P 500 stocks and others, the spending could limit the extent of a downturn.
The Money Driving Industrial Stocks
"Thirty to forty years of globalization is now in reverse," Jefferies analyst Stephen Volkmann told IBD.
Manufacturing is relocating to North America after decades of offshore migration. The reshoring of critical production represents a "massive megatrend," according to Volkmann. Even without legislation, that reversal would have given capital spending a nice lift, he says.
But don't underestimate the impact of $1 trillion in government outlays, even spent over a bunch of years, Volkmann says.
Congress approved $500 billion in new infrastructure spending in the fall of 2021. Then, last summer, Congress passed the CHIPS Act to boost domestic semiconductor production, with up to $250 billion in funding. The Inflation Reduction Act will put up $369 billion to expedite the mining and processing of key minerals and build out green energy infrastructure. That includes factories to make EV batteries, photovoltaic cells and wind turbine blades.
Volkmann adds that the multiplier effect — the additional investment generated by each dollar of federal infrastructure spending — could boost the full impact to $1.5 trillion or more.
In a Dec. 13 investor presentation, Terex, which makes materials processing and aerial work equipment, said recent legislation could fuel some $2.5 trillion in spending.
"Tremendous physical spend in the United States coming up over the next three to five years" should provide a good tailwind, Terex CEO John Garrison said at the event.
Ride Caterpillar Stock Or Play Defense?
The massive spending on mining, manufacturing, energy and highway infrastructure will flow through a broad range of end markets, influencing a larger number of S&P 500 stocks. Volkmann says winners will include heavy construction, distribution, electrical, HVAC, rental equipment and trucking.
The strength in nonresidential construction heralds good news for steelmakers such as Nucor (NUE). Its lead position in the rebar market also will pay dividends as road and bridge building gets a boost. And all that bodes well for cement-making giants Vulcan Materials (VMC) and Martin Marietta Materials (MLM). Both Nucor and Vulcan are S&P 500 stocks.
Arguably, though, no player has its hand in as many infrastructure pots as CAT stock. The S&P 500 and Dow Jones Industrial Average member is a major force in nonresidential construction, road building and mining. Caterpillar offers a growing line of hydrogen-blending diesels, helping companies meet emissions targets. Caterpillar's energy-sector business also stands to benefit from Europe's push to secure non-Russian energy capacity, including the buildout of terminals for shipping LNG.
In a Dec. 5 audio note, Barry Knapp, managing partner at Ironsides Macroeconomics, highlighted the recent leadership of the S&P 500 industrial stocks and materials sector. "Capital spending plans remain quite robust," he said, citing a "need to rebuild our manufacturing capacity" after years of underinvestment.
"We think this is going to be a long-term trend."
Near-Term Recession Worries For Industrial Stocks
But is CAT stock really in the catbird seat if the U.S. and other leading economies sit on the brink of recession?
A Dec. 14 note from BCA Research struck a more cautious position, advising investors to overweight defensive sectors over the next six to 12 months. Investors should seek more exposure to sectors such as health care for which demand is largely nondiscretionary, the note counseled.
The "deteriorating economic environment is a greater hurdle for cyclical equities (such as Caterpillar) relative to their defensive counterparts," BCA Research told clients.
Yet while the economy isn't out of the woods, investors have seized on hopes for a soft-landing, the government-spending tailwind and China's reopening to bid up industrials and materials stocks.
While the overall S&P 500 has climbed 11.1% since the end of Q3, the S&P 500 industrials and materials sectors have rallied more than twice as much. The S&P 500 industrials sector has climbed 24% and the materials sector 23%, topped only by the energy sector's 25% gain.
S&P 500 Stocks At Key Pivot Point
In general, S&P 500 stocks and the broader market are at a key pivot point. Inflation is receding, although service sector inflation has proved stubborn, according to Thursday's consumer price index data. The major indexes broke higher Jan. 6 as the December jobs report revealed a big slowdown in wage growth, which has become the Fed's major concern.
CPI Inflation Rate Slides As Service Prices Show Progress
Now markets are pricing in a lower peak Federal Reserve interest rate of 4.75%-5%, below the 5%-5.25% range Fed policymakers forecast in December. An earlier end to rate hikes would boost the chances of a soft landing for the U.S. economy, rather than a deeper downturn that could hammer cyclicals like industrial stocks.
Growing hopes for both a soft landing in the U.S. and a coming recovery in China have propelled a number of machinery and materials stocks past buy points in recent weeks.
Breakouts Among Industrial Stocks
United Rentals, the world's largest equipment rental company, and CAT stock both joined the IBD Leaderboard portfolio of elite stocks after clearing buy points in December. Commercial Metals, a leading rebar producer, has been hitting new highs after clearing a 50.93 buy point on Jan. 6. Terex, a recent IBD Stock Of The Day, is actionable on a move above its 50-day moving average and a break of its flat-base trendline.
CNH Industrial, a U.K.-based maker of construction and agricultural equipment, is another member of IBD's Machinery-Construction/Mining group that has scored a recent breakout. Terex and CNH are not S&P 500 stocks.
Still, the question for the U.S. economy is whether it will skirt recession or go into a contraction.
Momentum is clearly fading. Though the Labor Department reported a net gain of 223,000 jobs in December, employees worked fewer hours in aggregate in each of the past two months. Even if the Fed brings rate hikes to an end, it won't likely cut rates until the unemployment rate surpasses 4%, up from 3.5% now.
Machinery and materials stocks, like troops serving on the front lines, usually take it on the chin when the economic cycle turns ugly. They won't be unscathed this time around. But in this downturn they'll have an unusually protective bunker due to government spending, and the long-term outlook appears exceptionally bright.
'Sustained Investment Upcycle' For Machinery, Caterpillar Stock
Machinery suppliers "all expect a sustained investment upcycle," Baird analyst Mirce Dobre wrote in a Nov. 14 note. The negative impact of higher interest rates may be more than offset by the ramping up of infrastructure and industrial projects, he said.
The cycle for nonresidential investment, which accounts for about 30% of Caterpillar's revenue, usually lags residential investment, as high rates alter the economics of projects, prompting a reconsideration, Dobre says.
But this time looks different, he told IBD. "Demand remains robust, and there are enough tailwinds in the market to provide visibility." Among them: energy investment, infrastructure stimulus, reshoring of semiconductor capacity and the start of a multiyear replacement cycle for mining equipment that has grown very long in the tooth.
China Is A Wild Card For S&P 500 Stocks
Dobre adds that infrastructure investment is not just a story in the U.S. and Europe. It's also happening in the Middle East and other emerging economies that have used strong commodity prices and royalties to invest in public infrastructure.
The surge in prices of most commodities stalled out after spiking on Russia's invasion of Ukraine, then reversed lower. But a big wild card lies in the outlook for industrial stocks: China's reopening after abandoning its zero-Covid policy.
China accounts for only 3%-4% of Caterpillar sales, Volkmann says. That is down from nearly 10% in 2021. Still, a successful reopening would revive a key source of global commodities demand. After a year of being somewhat anemic, a rebound in China would only add urgency to mining investment.
Unlike the tech, housing and consumer goods sectors, industrial companies didn't really have a boom as the U.S. economy surged in 2021, Volkmann says. "Supply chains were all messed up," constraining output, he said. "We don't need a recession in the industrial space" to rationalize supply.
"Resource nationalism, mine strikes, depleted legacy mines and the long-awaited reopening of Chinese markets" should combine to produce higher copper prices, Deutsche Bank analyst Sean Wondrack wrote in a Jan. 3 report.
Copper, used heavily in plumbing pipe and fixtures, electrical wiring and components, acts as a key economic indicator. Copper prices have climbed out of a hole amid China's reopening from Covid. This week, copper futures crested $4 per pound for the first time since June.
S&P 500 Stocks Take A Long View — And Government Cash
Businesses tend to increase capital spending plans when current demand calls for new capacity. Yet even as recession clouds gather, major economic players are being driven by other, more lasting forces — and government money.
One of those forces is investments in decarbonization, which "are not tied to revenue or GDP growth (and in many cases are mandated)," Volkmann wrote in an Oct. 21 note. Another trend, reshoring, is "a reaction to increasing risks around trade and mitigating supply chain disruptions rather than an investment in new capacity," he wrote.
Many of these investments benefiting industrial stocks would have been made anyway. Yet the Biden administration and Congress have greased the wheels with generous funding and incentives.
The Semiconductor Industry Association just tallied up more than $200 billion in chip industry investments announced since the CHIPS Act was introduced in 2020. The bill took two years to cross the finish line.
The Inflation Reduction Act is generating the same kind of response for alternative energy investments.
Bernstein analyst Toni Sacconaghi has said that production incentives for EV battery cells and packs made in the U.S. could amount to $3,000-$4,000 per vehicle. The race to build lithium battery plants was already well underway, helping drive S&P 500 stocks like Albemarle (ALB).
But the new incentives have added fuel. Foreign automakers such as Honda Motor (HMC) and Toyota have responded by announcing new U.S. battery plants. S&P 500 stock General Motors (GM) is already boosting the planned capacity of its battery plant under construction in Tennessee. That's just one of four lithium-ion battery factories GM plans to build by 2024.
The law includes a 10% tax credit to offset production costs of key battery materials like lithium.
The New FAANG Stocks?
"Wind turbines, solar panels, EVs are all mineral or metal intensive," Bank of America Private Bank strategist Joe Quinlan said. "We are going to need much more supply of all these minerals whether it's lithium manganese, cobalt, nickel, you name it."
Rio Tinto, IBD Stock Of The Day, As China Emerges From Covid
Betting on a long upcycle for mining is part of Quinlan's FAANG 2.0 thesis that he rolled out following Russia's invasion of Ukraine. The thesis matches U.S. strategic needs in an inflationary world, putting "a premium on hard assets," Quinlan said. The new FAANG stands for Fuels, Aerospace and defense, Agriculture, Nuclear and renewables, and Gold and metals/minerals.
"The world is on the cusp of a global recession, which means a great deal of bad news is priced into equities," Quinlan said. That "means that this is a good entry point for equities for investors with a long-term horizon."
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