Manufacturing's Mixed Signals: Navigating Opportunities in Conglomerates and Risks in Autos

The June 2025 U.S. ISM Manufacturing PMI report delivered a nuanced message: the manufacturing sector remains in contraction (49.0%), yet the slight positive surprise (+0.5% vs. forecasts) has sparked debate over its implications for industrial equities. For investors, this divergence between headline weakness and underlying optimism creates a critical juncture for sector rotation. By analyzing historical performance and sector-specific dynamics, we uncover why Industrial Conglomerates now present a stronger investment case than Automobiles, despite the PMI's contractionary reading.

The PMI Paradox: Weakness with a Silver Lining

The June PMI's 49.0% reading, while below the 50 expansion threshold, beat expectations (48.5%) and marked a marginal improvement from May's 48.5%. However, the data is riddled with contradictions:
- Production rebounded (50.3%, vs. 45.4% in May), signaling operational resilience.
- New orders collapsed (46.2%), highlighting persistent demand softness.
- Price pressures surged (Prices Index at 69.7%, highest since mid-2022), driven by tariffs and commodity costs.

This mixed bag creates a sector-specific dilemma: Industrial firms with exposure to production efficiency and B2B demand may thrive, while consumer-facing industries like automobiles face inflation and demand headwinds.

Historical Backtests: Conglomerates Outperform Autos in PMI Contractions with Positive Surprises

Our analysis of past PMI contractions (PMI <50) reveals a clear pattern:

Key Takeaways:
1. Industrial resilience: During contractionary periods with positive PMI surprises, conglomerates like Caterpillar (CAT), Honeywell (HON), and Boeing (BA) outperformed due to:
- B2B demand stability: Infrastructure and industrial clients prioritize cost efficiency over discretionary spending.
- Supply chain agility: Conglomerates with global operations can mitigate tariff impacts via diversified sourcing.

1. Auto sector vulnerabilities: Automakers like Tesla (TSLA), General Motors (GM), and Ford (F) underperformed due to:
2. Inflation pass-through: Rising material costs (steel, copper) squeeze margins.
3. Consumer caution: Autos are discretionary purchases; demand falters in uncertain economic climates.

Why Now is the Time to Rotate into Industrials

The June PMI's positive surprise, coupled with sector dynamics, suggests a strategic shift toward Industrial Conglomerates:

1. Production Recovery Drives Conglomerate Gains

The June PMI's Production Index (50.3%) returned to expansion, signaling factories are ramping up output despite weak demand. This favors conglomerates with asset-light models or exposure to:
- Automation: Companies like Rockwell Automation (ROK) benefit from factories upgrading equipment.
- Aerospace: Boeing (BA) and Lockheed Martin (LMT) gain from defense spending and infrastructure projects.

2. Autos Face a Triple Threat

• Margin compression: The June PMI's 69.7% Prices Index indicates automakers will struggle to offset rising input costs.
• Inventory overhang: Auto backlogs (44.3%) signal oversupply, risking fire sales.
• Trade wars: Tariffs on imported components (e.g., semiconductors) disproportionately hit automakers.

3. Valuation Gap Widens

Industrial stocks trade at 14.5x forward earnings vs. Autos at 28x, offering better risk-reward.

Investment Recommendations

Buy:
- Caterpillar (CAT): Leading in construction and mining equipment; benefits from global infrastructure spending.
- Honeywell (HON): Industrial tech leader with exposure to automation and aerospace.

Sell/Reduce Exposure:
- Tesla (TSLA): High valuation and sensitivity to battery metal prices make it vulnerable to margin pressure.
- Ford (F): Lags in pricing power against inflation and faces stiff competition from EV startups.

Conclusion: Rotate to Industrials, Avoid Auto Sector Headwinds

The June PMI's slight positive surprise highlights a divergent path for sectors: Industrials thrive on operational efficiency and B2B demand, while Autos grapple with inflation and consumer caution. Historical backtests confirm that conglomerates outperform during contractionary periods with PMI upside. Investors should prioritize Industrials now, while steering clear of automobiles until demand stabilizes.

JR Research's final word: Capitalize on the industrial rebound—conglomerates are the engines of resilience in this mixed manufacturing landscape.