Industrials Sector Downturn: A Contrarian's Opportunity in Resilient Firms

The U.S. manufacturing sector is in its second consecutive month of contraction, with the May 2025 ISM Manufacturing PMI® falling to 48.7%, marking the 18th contraction in 19 months. While the broader industrials sector faces headwinds from Fed policy uncertainty and global trade shifts, this downturn presents a contrarian investing opportunity. Investors should focus on firms with exposure to inflation-resistant sectors, supply chain reshoring tailwinds, and pricing power—such as Carrier Global Corp (CARR)—while avoiding overexposure to tariff-sensitive peers. Here's why.

The Industrials Downturn: A Sector-Wide Reality Check

The May PMI® data underscores a deepening demand slump. New orders fell to 45.4%, their lowest level in 20 months, with housing and capital spending sectors hardest hit. Backlogs of orders (42.4%) and inventories (47.9%) remain in contraction, reflecting weak demand and cautious inventory management. Even employment, which expanded modestly to 51.1%, masks sectoral divides: hiring grew in food and chemical sectors but stalled in machinery and electronics. Meanwhile, prices for key commodities like aluminum and copper remain elevated, though steel costs have eased.

Why Contrarian Investing Works Now

The industrials sector's decline has created dislocations, with many companies trading at multiyear lows. However, the downturn is not uniform. Resilient firms operating in structural growth areas—such as HVAC, building automation, and supply chain localization—are poised to outperform. These sub-sectors benefit from three key trends:
1. Inflation-Resistant Demand: Infrastructure spending, retrofitting for energy efficiency, and commercial building automation are less cyclical and more tied to long-term policy goals like decarbonization.
2. Supply Chain Reshoring: Companies with domestic manufacturing footprints or exposure to U.S. government programs (e.g., CHIPS Act semiconductor incentives) are insulated from global trade volatility.
3. Stable Pricing Power: Firms with niche expertise or proprietary technology can pass cost increases to customers, unlike commoditized players.

Carrier Global Corp (CARR): A Contrarian Gem

Carrier, a subsidiary of United Technologies (now Raytheon Technologies), is a prime example of a resilient industrial firm. Its core businesses—HVAC systems, building automation, and fire safety solutions—are critical to commercial and residential infrastructure. Key positives:
- Inflation Hedge: Its products are tied to long-term building projects, which are less sensitive to near-term demand swings.
- Reshoring Tailwinds: Carrier has invested in U.S. factories to serve domestic demand, reducing reliance on global supply chains.
- Cost Discipline: The company has trimmed legacy overhead, improving margins even as input costs rise.

Investment Thesis: CARR's valuation—currently trading at 12x forward earnings, below its five-year average of 15x—reflects broader sector pessimism. However, its backlog of orders (which, while contracting, remains healthier than peers') and strong cash flow suggest it can weather the downturn.

Risks and Red Flags

Not all industrials are safe. Avoid firms overly exposed to:
- Tariff-Sensitive Sectors: Companies reliant on Chinese imports (e.g., machinery with Chinese components) face margin pressure as U.S.-China trade tensions persist.
- Export-Heavy Models: Firms like Caterpillar or Deere, which depend on global construction demand, are vulnerable to weak overseas growth.
- Inventory Gluts: Electronics and computer equipment manufacturers (e.g., Intel) face excess inventory and softening IT spending.

Fed Policy: A Double-Edged Sword

The Fed's June 2025 projections—keeping rates high until 2026—add uncertainty. Higher borrowing costs will dampen capital spending, but they also signal inflation is under control, which benefits firms with pricing discipline. Investors should monitor new orders and supplier deliveries (the May PMI® noted stable lead times), as these are forward indicators of demand.

Conclusion: Pick the Winners, Avoid the Losers

The industrials sector's downturn is a function of broader macroeconomic challenges, but it is far from a uniform disaster. Contrarian investors should focus on firms like Carrier Global Corp, which benefit from structural trends in infrastructure and reshoring. Meanwhile, steer clear of companies dependent on global trade or discretionary spending.

Actionable Advice:
1. Long CARR: Target entry at 12x forward earnings, with a price target of $45–50 based on a normalized 14x multiple.
2. Short Tariff-Sensitive Peers: Consider inverse ETFs like RIND (ProShares Short Industrials) or single-stock shorts in trade-exposed firms.
3. Monitor PMI® New Orders: A rebound above 50 would signal a cyclical upturn, while a drop below 45 could trigger deeper sector cuts.

The Industrials Sector's slump is a test of patience—but for those willing to sift through the rubble, there are diamonds in the rough.

Disclaimer: Past performance does not guarantee future results. Investors should conduct their own due diligence and consult a financial advisor before making investment decisions.