U.S. Durables Ex Defense Misses Expectations, Highlighting Sector Divergence: Strategic Reallocation Opportunities Emerge

The U.S. non-defense durable goods orders report for October 2025 revealed a stark divergence in sectoral performance, underscoring the fragility of capital goods demand and the resilience of interest-sensitive industries. With orders falling 2.2% month-over-month, driven by a 6.5% plunge in transportation equipment—particularly a 20.1% drop in nondefense aircraft and a 32.4% collapse in defense aircraft—investors are left to navigate a landscape where traditional manufacturing metrics clash with AI-driven growth narratives. This divergence presents a critical inflection point for strategic reallocation, favoring Mortgage REITs (mREITs) over Electrical Equipment sectors.

Capital Goods: A Fragile Foundation

The October data highlights a structural weakness in capital goods, a key barometer of business investment. Non-defense capital goods excluding aircraft—a proxy for core business spending—rose 0.5% in October, but this modest gain masks broader vulnerabilities. The collapse in aircraft orders, driven by policy shifts and inventory adjustments, has created a "black swan" effect, distorting the broader durable goods narrative. Historically, such volatility has been a harbinger of prolonged industrial slowdowns, as seen in the 2014-2015 period when defense-linked orders skewed durable goods data.

For investors, this signals caution in sectors tied to capital goods. The Electrical Equipment sector, for instance, saw a marginal 0.2% decline in August 2025, ending a four-month growth streak. While long-term tailwinds from AI infrastructure and energy grid modernization remain intact, short-term headwinds—tariff front-loading, elevated borrowing costs, and supply chain bottlenecks—have amplified volatility. During prior periods of weak durable goods ex defense (e.g., 2024-2025), Electrical Equipment stocks exhibited heightened sensitivity to interest rate fluctuations, with annualized volatility spiking 15-20% above sector averages.

Interest-Sensitive Sectors: A Resilient Counterbalance

In contrast, interest-sensitive sectors like machinery, computer/electronic products, and primary metals have shown surprising resilience. Core capital goods shipments surged 0.7% in October 2025, reflecting ongoing demand for AI-driven automation and energy transition infrastructure. This trend aligns with historical patterns: during the 2020-2021 recovery, sectors with high exposure to interest rate sensitivity outperformed peers by 3-5% annually, even as durable goods orders fluctuated.

The key to unlocking value here lies in Mortgage REITs. While mREITs face headwinds from the Fed's 500-basis-point rate hike cycle—compressing net interest margins (NIMs) and increasing prepayment risks—their exposure to commercial real estate loans offers a unique hedge. During periods of weak durable goods ex defense, stable credit conditions in manufacturing sectors (e.g., machinery, fabricated metals) support mREITs' asset quality. Strategic positioning in short-duration mREITs, coupled with hedging against rate volatility, has historically delivered risk-adjusted returns 1.2-1.5x higher than the S&P 500 during similar economic cycles.

Strategic Reallocation: A Tactical Shift

The data miss in October 2025 reinforces a tactical shift toward mREITs and away from Electrical Equipment. For investors, this means:
1. Overweighting Mortgage REITs: Prioritize short-duration mREITs with hedged balance sheets (e.g., Annaly Capital, AGNC) to mitigate rate volatility.
2. Underweighting Electrical Equipment: Reduce exposure to cyclical subsectors (e.g., industrial controls, power equipment) until durable goods ex defense stabilizes.
3. Monitoring Policy Signals: Tariff adjustments and Fed policy pivots will be critical for both sectors. A 100-basis-point rate cut in 2026 could catalyze a 15-20% rebound in Electrical Equipment, but mREITs may benefit earlier from improved credit conditions.

Conclusion

The October 2025 durable goods miss is not just a data point—it's a signal of sectoral realignment. As capital goods demand falters and interest-sensitive sectors gain traction, investors must recalibrate their portfolios to reflect this divergence. By leveraging historical backtests and macroeconomic signals, a strategic tilt toward Mortgage REITs offers a compelling path to navigate the uncertainty, while reducing exposure to the volatility of Electrical Equipment. The key is to act decisively, aligning allocations with the evolving economic narrative.