What Exactly Constitutes The Industrial Sector? (XLI, ITA, VIS, EVX, UPS, UTX, CAT, MMM, GE, BA, LMT)

Ron Rowland: I’ve been investing in sectors for more than 25 years — first with mutual funds and now ETFs. Following the trends from one industry to the next is one of the best investment strategies I know.

Yet I have to admit some sectors rarely show up on my radar screen. Today I’ll tell you about one of them — and how you can take advantage of this much-ignored group.

Industrials: The Stocks Without a Home

The neglected sector I’m thinking about is Industrials. Oddly, this category includes some very large, well-known stocks. The problem is they are hard to categorize.

Classifying stocks into sectors is a bit like sorting books on a shelf. Whatever scheme you may want to follow, you always end up with a few titles that just don’t fit … or maybe they fit more than one place.

Sometimes the sector lines are clear. For example, Wells Fargo (NYSE:WFC) is a bank and Pfizer (NYSE:PFE) is a pharmaceutical company. We all know what they do and how they make money.

But what about General Electric (NYSE:GE)?

If you have to describe GE in one word, the word would be “conglomerate.” The company is involved in a wide assortment of businesses including …

  • Clean energy
  • Nuclear power
  • Jet engines
  • TV networks (like CNBC)
  • Consumer finance
  • Medical equipment
You name it, they probably do it.
You name it, they probably do it.

… and this just scratches the surface. Based on its profits, GE is arguably more of a financial services stock than anything else. But you won’t find it in financial sector funds. The other businesses are significant, too.

The big index providers can’t ignore GE, of course. They have to put it somewhere. So it lands in the “industrials” sector.

Exactly What Is an “Industrial” Company?

Under the scheme now used by index providers like S&P, industrial companies are those whose business consists of capital goods, commercial and professional services, and transportation.

GE is involved in all those areas, so Wall Street calls it an “industrial” stock — and the largest one by far. Most industrial sector ETFs are top-heavy with GE shares.

  • SPDR Industrial (NYSEARCA:XLI) has 11 percent of its portfolio in GE. This is almost twice as much as XLI allocates to the next-biggest holding, United Parcel Service (NYSE:UPS).
  • Vanguard Industrials (NYSEARCA:VIS) allocates over 12 percent of its portfolio to GE — three times more weight than it gives second-place United Technologies (NYSE:UTX).
  • iShares Dow Jones U.S. Industrials (NYSEARCA:IYJ) loves GE, too, with a weighting over 11 percent and only 3-4 percent in true industrials like Caterpillar (NYSE:CAT) and 3M (NYSE:MMM).
  • iShares S&P Global Industrials (NYSEARCA:EXI) looks at the sector from around the world. Even taking a global approach, GE comes in with an 8 percent weighting.

In other words, if you want “industrials” in an ETF, you also get GE … like it or not. This is one reason many investors ignore the sector — it’s not truly a “pure” play like most sector ETFs.

That’s too bad, because there are times when you really do want to own this group. Fortunately, I can tell you about another way.

For Real Industrials, Go Deep!

The solution is to ignore the broader sector funds like those listed above. Avoid the GE entanglement by going a step deeper into ETFs covering industrial niches.

One business where the U.S. is still the undisputed leader is aerospace. Thanks to our massive defense budget, we own the market for aircraft, weapons systems, and related technologies.

The U.S. is still the leader in military and aerospace technology.
The U.S. is still the leader in military and aerospace technology.

With an ETF like iShares Dow Jones U.S. Aerospace & Defense (NYSEARCA:ITA), you can have a cross-section of the whole group (minus GE). ITA’s top holdings include United Technologies (NYSE:UTX), Boeing (NYSE:BA), Lockheed Martin (NYSE:LMT), General Dynamics (NYSE:GD), Raytheon (NYSE:RTN), and more.

U.S. companies are also world leaders in environmental services — an increasingly important requirement for all kinds of businesses. Here again, you can participate with an ETF. Consider Market Vectors Environmental Services (NYSEARCA:EVX).

Finally, don’t forget the transports! Despite today’s astronomical fuel prices, shipping is still a huge and profitable business. iShares Dow Jones Transportation Average Index Fund (NYSEARCA:IYT) tracks the venerable benchmark and is very liquid.

ETFs like these are the best way around the “GE” problem. Another way is to consider using an alternatively weighted ETF like First Trust Industrials/Producer Durables AlphaDEX (NYSEARCA:FXR) or Guggenheim S&P 500 Equal Weight Industrials (NYSEARCA:RGI). Both tend to keep their GE allocations below 2 percent.

What if you really do want GE?

You can always buy shares individually. I’m not a big fan of individual stock trading, but GE has a built-in diversification factor. Depending on your needs, a small slice may be a good long-term holding. Just don’t ask me what sector you should file it with!

Best wishes,

Written By Ron Rowland From Money And Markets

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss  along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson. To avoid conflicts of interest, Weiss Research and its  staff  do not hold positions in companies recommended inMaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not  guaranteed. Performance returns cited are derived from our best  estimates but must be considered hypothetical in as much as we do not  track the actual prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene  Ceballo, Amber Dakar, Maryellen Murphy, Jennifer Newman-Amos, Adam  Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle  Zausnig.

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