Industrials Sector Snapshot

An introduction to the Industrial Select Sector SPDR Index (XLI)

When seeking exposure to the US industrials sector, many investors consider XLI, an ETF tracking a subset of the S&P 500 called the Industrial Select Sector Index. Launched in 1998, it’s one of the oldest and largest industrial ETFs. 

XLI is one of the 11 Select Sector SPDR ETFs, which share key characteristics like large assets under management (AUM), low expense ratios of 0.09%, and excellent liquidity. These SPDR ETFs are passively managed and their portfolios are constructed using a modified market capitalization approach. While this often results in a concentrated top 10 holdings, XLI stands out for its diversification, with no single stock exceeding a 5% weight and the top 10 holdings comprising only 35.5% of the fund. Additionally, XLI is more diversified than the average Select Sector SPDR ETF, with a total of 78 holdings. It stands out as one of the most diversified and equally weighted Select Sector SPDR ETFs, typically aligning with the performance of broader indices and offering a market-average dividend yield of 1.5%.

12-Month XLV Performance Versus S&P 500

A look inside 

XLI’s market cap exceeds $18 billion, comprised of 78 holdings spread out across 12 sub-sectors:  

• Aerospace & Defense (23%)

• Machinery (19%)

• Ground Transportation (12%)

• Electrical Equipment (8%)

• Professional Services (8%)

• Commercial Services & Suppliers (7%)

• Building Products (6%); Industrial Conglomerates (5%)

• Air Freight & Logistics (5%)

• Trading Companies & Distributors (3%)

• Airlines (2%)

• Construction & Engineering (1%)

Top 10 XLI Holdings

Some tailwinds

Industrial companies are closely tied to monetary and economic policies since they produce goods, technologies, and services essential to sectors like construction, manufacturing, aerospace, and agriculture. These companies tend to thrive during periods of economic growth and are often seen as indicators of broader economic health. Currently, the economy seems poised for a soft landing, with the Federal Reserve successfully reducing inflation to around 3% from a peak of 9.1% in June 2022 without triggering a recession. The US economy showed strong growth last year with a 2.6% increase in GDP. An anticipated rate cut in September is expected to further stimulate economic activity.

Earnings growth, a key driver of stock prices, is likely to strengthen in the coming quarters. For example, General Electric (GE) posted double-digit growth in profit, orders, and cash flow in its second quarter, leading it to raise its full-year earnings guidance. Similarly, RTX (RTX) and Lockheed Martin (LMT) also increased their full-year sales and earnings forecasts after surpassing second-quarter estimates. Caterpillar (CAT) recently boosted its dividend by 8.5% and expanded its share repurchase program by $20 billion, supported by strong cash flows and steady earnings growth. Honeywell International (HON) also exceeded revenue and earnings expectations in the second quarter, raised its revenue guidance, and is expected to increase its dividend significantly.

Industrials ETFs like XLI could also benefit from investors shifting away from tech stocks, which currently trade at high valuations and face potential slowing growth. This combination may lead to a correction in tech stock prices. Recent market trends indicate that this rotation has already started, with tech stocks declining sharply over the last several weeks while defensive sectors like healthcare, financials, and industrials have experienced growth.

Last Month XLV Performance vs S&P 500 vs XLK (Tech Select Sector Index)

Key risks

While industrial companies have a history of long-term growth, the sector still faces risks, particularly related to the US economy. Prolonged high interest rates could slow economic growth, affecting industries like construction, machinery, and infrastructure. With a beta around 1, the sector's performance is closely tied to broader stock market trends and could decline in bearish conditions.