Beneath the Headlines: Why Core Capital Goods Signal a Buying Opportunity in Industrials

The May 2025 U.S. durable goods orders report delivered a shock: new orders fell by 2.2% month-over-month, the largest drop since 2014. Investors reacted swiftly, trimming positions in industrial equities. But beneath the alarming headline number lies a critical truth: non-defense capital goods excluding aircraft—a leading indicator of business investment—showed resilience, rising 0.1% in March and holding steady in early 2025. This suggests that while manufacturing faces near-term turbulence, the underlying confidence of businesses in future growth remains intact. For investors, this divergence between headline volatility and core strength presents a compelling opportunity to buy into industrials at depressed valuations.

The Volatile Surface: Why the Durable Goods Drop Isn't the Whole Story

The May decline was driven by a 7.4% plunge in transportation equipment, with non-defense aircraft orders collapsing by 45.7%. This collapse reflects Boeing's struggles to secure orders from key markets like China, exacerbated by lingering trade tensions and geopolitical friction. But transportation is notoriously volatile, accounting for just 20% of total durable goods orders. When stripped out, the remaining sectors—machinery, computers, and primary metals—showed a modest 0.3% increase. Even defense orders, a component often tied to geopolitical jitters, declined only modestly.

The true health of business investment lies in non-defense capital goods excluding aircraft, a subset of orders that excludes both defense spending (which is government-driven) and aircraft (which are highly cyclical). This metric has averaged 0.25% monthly growth since 1992 and is closely watched as a proxy for private-sector capital spending. In March 2025, it rose to $74.78 billion, up 1.1% year-over-year, despite the broader downturn. As Patrick Horan of the Mercatus Center noted, “This metric has consistently led the economy through cycles. Its stability now suggests that businesses aren't pulling back on long-term investments.”

Why the Core Metric Matters: Historical Context and Forward Guidance

The reliability of non-defense capital goods excluding aircraft as a leading indicator is well-documented. In 2010, a 9.5% monthly surge in this metric preceded a manufacturing rebound. Conversely, its 10.8% collapse in early 2009 foreshadowed the Great Recession. Today's data, while muted, does not signal a coming downturn.

The chart above shows this metric holding near its 2024 average, despite erratic swings in transportation and defense. Even during the post-pandemic inventory correction of late 2024, core capital goods orders never fell below a 0.5% monthly pace, a stark contrast to the broader manufacturing sector. This stability reflects businesses' focus on upgrading machinery and software—investments less tied to cyclical demand than to productivity gains.

The Case for a Buying Opportunity: Valuations and Catalysts

Industrial equities have sold off sharply in response to the durable goods report, with the S&P 500 Industrials index down 8% year-to-date. Yet fundamentals remain stronger than prices suggest.

• Valuations are attractive: The sector trades at 14.5x forward earnings, below its five-year average of 16.2x.
• Profitability is holding: Companies like Caterpillar and Deere report solid margins, with cost-cutting offsetting slower sales growth.
• Cyclical tailwinds: A Federal Reserve poised to pause its rate hikes, combined with easing trade tensions, could stabilize capital spending.

Investors should focus on firms with exposure to core capital goods: machinery manufacturers, industrial tech providers, and logistics firms. Caterpillar, for instance, has lagged the broader market despite a 20% rise in backhoe loader orders in Q1 2025. Similarly, companies like Rockwell Automation, which supplies automation software to manufacturers, offer exposure to secular trends in productivity investment.

Risks and Mitigations

The risks are clear: a prolonged trade war, a sharper-than-expected slowdown in China, or a recession in the U.S. could derail capital spending. But these risks are already priced into industrials. Meanwhile, the core capital goods data suggests that businesses are making investments for the long term—upgrading equipment rather than cutting capacity.

Conclusion: Look Beyond the Headline

The May durable goods report was a false signal. Investors should separate the noise of transportation volatility from the signal of resilient core investment. With valuations low and fundamentals holding, now is the time to position for a rebound in industrials. The next Federal Reserve meeting and trade talks with China could provide catalysts, but the real story is in the data: businesses aren't just surviving—they're preparing to grow.

For conservative investors, consider a phased approach, using dips to accumulate positions in industrials ETFs like XLI. For those with higher risk tolerance, sector leaders like Caterpillar or Deere offer asymmetric upside if capital spending stabilizes.