America’s factories appear to be staging a springtime renaissance. In late March, the U.S. Commerce Department said that orders for durable goods (those lasting three years or longer) rose about nine percent from a year ago. That growth rate is a six-year high. And the Institute for Supply Management on Monday said its index of factory activity settled at 59.3 in March, right near the highest levels of the past decade.
The upturn may be due to the recent revamp of the tax code. A reduction in tax rates on foreign-sourced profits means that billions of dollars are now being repatriated back to the U.S., and that means dividend increases, share buybacks and strategic acquisitions are all expected to be clear beneficiaries of the rising corporate cash balances.
And we’ve also gotten a clear read on the fourth pillar of cash deployment: capital investments. An upgrade in plant and equipment is crucial for companies that look to handle a growing backlog of orders.
Companies aren’t making greater investments in their plants and equipment just because they now have more domestic cash to spend. They’re also responding to newly favorable tax treatment for such investments. In the past, such investment in equipment had to be capitalized and slowly expensed over the course of their estimated life span. Now such spending can be expensed right away.
“For firms that have a lot of cap ex (capital expenditures), they can realize a much quicker payback on their investments,” says Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors.
That rule will slowly start to be phased out starting in 2023, so many companies may look to boost their level of spending before then to take advantage of that tax break.
The surge in factory output means that industrial-focused exchange-traded funds should prove to be timely investments. The Industrial Select Sector SPDR Fund (XLI) is the largest in the category, with a hefty $12.8 billion in assets. That’s larger than the next four industrial ETFs combined. Part of the fund’s appeal is its category-low 0.13 percent expense ratio. The market cap-weighted fund provides hefty exposure to the largest firms in the sector such as Boeing, 3M, General Electric, Honeywell and Union Pacific. The top 10 holdings account for roughly 45 percent of the portfolio.
Those large companies are especially well-positioned for the current upward phase of global economic growth. Roughly 40 percent of industrial sector sales are made to foreign buyers, according to State Street Research. The fact that the dollar has now weakened for five straight quarters strengthens the value proposition for U.S. multi-nationals against their foreign rivals.
And like many other industrial ETFs, the XLI fund also has ample exposure to aerospace/defense stocks such as Lockheed Martin and Raytheon, in addition to Boeing. The timing is good because Congress has just authorized an increase in defense spending for the next few fiscal years.
While XLI is a solid choice for low-cost broad-based exposure, more than a dozen other ETFs aim to provide a more targeted investment strategy. The First Trust Industrials/Producer Durables AlphaDEX Fund (FXR), for example, takes a smart beta approach by tracking an underlying index focused on two distinct factors.