A False Recession Signal Is Here: Analyst Torches Theory Around Industrial Stocks

Industrial stocks are getting a lot of attention from investors as a potential recession sign. The theory is pretty simple; if construction companies like Caterpillar Inc (NYSE: CAT) and Honeywell Inc (NASDAQ: HON) are struggling, it could indicate weakness in the overall economy as demand for building materials and supplies drop because businesses cut back on spending. 

But, Jessica Rabe, co-founder of Datatrek, argues that weakness in industrial stocks has not been a reliable indicator of recessions in the past. The last time that industrials showed above-average weakness compared to the S&P 500, was in March 2020 when the COVID-19 pandemic shut down many parts of the economy.

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“When industrials have lagged the S&P 500 by 2 standard deviations, it’s been a false signal of recession (Nov 1999/Sept 2021) or concurrent w/ an economic downturn (March 2009/2020),” DataTrek reports. 

Rabe also points out that much of the weakness in the industrial sector comes from the top: the top-10 holdings in the S&P Industrials Sector ETF are down more than 2% on average YTD, while the rest of the holdings are up more than 4%. 

Lockheed Martin (NYSE: LMT) and RTX Corp (NYSE: RTX), both top-10 holdings in the industrial sector ETF, are expected to see a significant regression in earnings in 2024 compared to 2023. This could help explain why there is a disconnect between weakness in industrial stocks and an overall recession. Just because there’s a drop-off in demand for defense-related supplies, does not necessarily mean that there will be an overall downturn in the economy.

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