Industrial stocks are experiencing a boom, driven by the massive infrastructure buildout required for artificial intelligence and a rise in global defense spending. The S&P 500 industrials sector is trading at a price-to-earnings (P/E) ratio above 30, significantly higher than its long-term average of around 20, and even surpassing the P/E ratios of consumer discretionary and information technology sectors. This indicates strong investor confidence in the sector's growth potential. Wells Fargo analysts note that AI spending is "trickling down" to old-line industrial stocks, with capital-goods firms benefiting from the construction of new data centers.
The AI infrastructure boom necessitates new electrical substations, enhanced high-speed fiber internet, and advanced energy-saving battery technology. This demand has led to a surge in production firms within machinery (20.89% of XLI holdings) and electrical equipment industries (14.16% of XLI holdings). Major players like Caterpillar and GE Vernova have seen their stock prices rise over 50% this year, with Caterpillar up nearly 160% in two years. Emerson Electric and Hubbell have also shown significant gains, with Hubbell up 30% over the past two years. Google (Alphabet) alone projects capital expenditures of $195 billion to $205 billion this year, an increase from previous guidance.
Defense spending is another key driver for the industrial sector. Lockheed Martin and RTX Corp., both significant holdings in industrial ETFs, are up approximately 35% over the past year. Lockheed Martin recently reported strong quarterly earnings, leading to a 10% post-earnings rally. Aerospace and defense companies account for 25% of the XLI's sector allocation. The iShares Defense Industrials Active ETF (IDEF) leads industrial ETFs with $4.4 billion in assets, followed by the State Street Industrial Select Sector SPDR (XLI) with $3.6 billion. Collectively, industrial ETFs have seen $23 billion in net inflows year-to-date, with $17 billion specifically flowing into core industrial funds, demonstrating robust investor interest.
Despite the enthusiasm for AI and defense-driven industrials, some fund managers, like Bertrand Cliquet of Lazard Global Listed Infrastructure Portfolio, emphasize looking beyond these megatrends. His fund focuses on lower-risk infrastructure businesses in energy, water, transport, and communications, particularly in Europe, where long-term drivers like energy transition and water resource investments are significant. While the U.S. market is important, with holdings like National Grid and Exelon, Cliquet notes that European companies often have more compelling long-term drivers beyond data centers. He also highlights telecom tower businesses like American Tower REIT and Crown Castle, and Consolidated Edison, which benefits from stable regulation in New York.
Individual industrial stocks are trading at elevated forward earnings multiples, reflecting investor bullishness on AI and defense. GE Vernova is at 53.0x, General Electric at 43.9x, Caterpillar at 30.5x, Eaton at 30.4x, RTX at 30.1x, and Parker Hannifin at 30.1x. These multiples are well above the S&P 500's average of 20x, indicating a premium paid for exposure to these secular growth trends. Conversely, companies less tied to these themes, such as Uber (17x) and Union Pacific (22.2x), trade at comparatively discounted valuations.
