Philadelphia Manufacturing Recovery: A Tactical Buy Signal for U.S. Industrials?

The U.S. manufacturing sector is at a crossroads. While the Philadelphia Federal Reserve’s May 2025 Manufacturing Business Outlook Survey signals a tentative stabilization in regional activity, the Empire State Manufacturing Survey paints a bleaker picture of ongoing contraction in New York. This divergence offers investors a nuanced opportunity: a tactical tilt toward select industrial stocks and ETFs, provided one navigates tariff risks and macro uncertainties with precision.

Philly Fed: A Glimmer of Hope in the Dark

The Philadelphia Fed’s May data reveals a sector inching toward recovery. The current general activity index rose to -4.0, a sharp rebound from April’s -26.4, though it remains in contractionary territory. New orders surged to 7.5, nearly erasing April’s slump, while employment rose to 16.5, with 23% of firms hiring. Crucially, future expectations are soaring: the six-month outlook for general activity jumped to 47.2, the strongest since mid-2023. This optimism is underpinned by rising capital expenditures (27.0) and new orders (49.7), suggesting firms are betting on a demand rebound.

The pricing data, however, underscores persistent inflationary pressures. Input costs hit a two-year high (59.8), while firms raised output prices (43.6), with 44% passing on costs to customers. Yet, customer price sensitivity rose (43% of firms noted increased sensitivity), hinting at a balancing act between cost management and demand retention.

Empire State: The Elephant in the Room

In contrast, the Empire State Manufacturing Survey’s May reading of -9.2—its third consecutive monthly decline—paints a grim picture for New York’s manufacturers. Hiring and hours worked plummeted, with employment falling to -7.1 and hours to -10.4, signaling a labor market in retreat. While input costs rose sharply (59.0), the lack of improvement in new orders or shipments suggests regional demand remains weak. This geographic split—Philadelphia’s cautious optimism vs. New York’s malaise—implies that sector recovery will be uneven, favoring firms with exposure to resurgent East Coast markets.

Tariffs: A Double-Edged Sword for Industrials

The trade war’s impact looms large. Companies like Deere (DE), a Philadelphia-based industrial giant, face dual pressures: rising input costs due to tariffs on steel and aluminum, and retaliatory duties on exports. Deere has responded by realigning supply chains, shifting production to Mexico and optimizing logistics. Similarly, Merck (MRK)—though primarily a pharmaceutical firm—may see cost pressures from tariffs on active pharmaceutical ingredients.

Investors should favor industrials with geographic or supply chain agility. Deere’s recent focus on autonomous farming equipment aligns with a post-tariff world, while Merck’s diversification into generics could mitigate input cost risks.

ETF Play: XLI and IYJ—Tactical Buys with Caveats

The Industrial Select Sector SPDR Fund (XLI) and iShares U.S. Industrials ETF (IYJ) offer broad exposure to this sector. Both track companies like Boeing, Caterpillar, and 3M, which benefit from rising capital expenditures and infrastructure spending.

However, trade war escalation could reverse gains. Monitor tariff negotiations closely: if U.S.-China tensions ease, industrials could outperform. Conversely, a renewed escalation could send XLI and IYJ into a tailspin.

The Case for Action—Now

The Philly Fed’s data suggests a sector-specific cyclical recovery is underway, driven by pent-up demand and capital spending. With the S&P 500 Industrials trading at a 15% discount to its 10-year average P/E ratio, valuations are compelling.

Tactical recommendation:
- Allocate 5–7% to XLI or IYJ, with a focus on high-quality industrials.
- Avoid pure-play exporters exposed to retaliatory tariffs.
- Hedge with inflation-protected bonds to offset rising input costs.

Conclusion: Proceed with Caution

The Philadelphia Fed’s rebound is a buy signal for industrials, but investors must remain vigilant. While the sector’s cyclical upturn is real, the Empire State’s struggles and tariff risks remind us that the path to recovery is uneven. For those willing to bet on a geographically selective, tariff-resilient portfolio, now is the time to act—before the next macro storm clouds gather.

Invest wisely, and stay agile.