MW This S&P 500 sector is expected to grow profits most rapidly through 2026 - and it's not tech. Here are 14 related stocks.
By Philip van Doorn
Two money managers discuss what lies ahead for a reviving sector
If you asked which sector of the S&P 500 was expected by analysts to increase its sales and earnings at the fastest pace over the next two years, you would probably expect the information technology sector to be at the top.
After all, Nvidia Corp. $(NVDA)$, which is now the third-largest component of the S&P 500 SPX - making up 6.3% of the SPDR S&P 500 ETF Trust SPY - increased its sales for the most recent quarter by 262% from the year-earlier quarter, while its earnings per share rose 461%. And Microsoft Corp. $(MSFT)$, which is the largest component of the S&P 500, with a 7% weighting in SPY, increased those by 17% and 20%, respectively.
But we are looking ahead.
Here are projected compound annual growth rates from 2024 through 2026 for the 11 sectors of the S&P 500, based on weighted consensus estimates among analysts polled by FactSet. The estimates are adjusted to match calendar years for the roughly 20% of companies in the index whose fiscal years don't match the calendar. The table is sorted by expected sales CAGR, with the full index at the bottom.
Sector or index Two-year estimated sales CAGR through 2026 Two-year estimated EPS CAGR through 2025
Industrials 7.5% 15.0%
Consumer Discretionary 7.1% 14.7%
Real Estate 6.4% 6.5%
Information Technology 6.3% 14.8%
Healthcare 6.1% 14.8%
Communication Services 5.8% 13.1%
Financials 4.6% 11.1%
Consumer Staples 4.0% 7.6%
Utilities 3.9% 8.3%
Materials 3.8% 14.4%
Energy 0.3% 9.8%
S&P 500 5.6% 13.0%
Source: FactSet
Are you surprised? The industrial sector ranks highest for expected two-year revenue and earnings-per-share CAGR through 2026. The IT sector ranks fourth for expected sales growth and is in a second-place tie with the healthcare sector for expected EPS growth.
Two money managers explain what drives industrial projections
According to Spenser Lerner, the head of multi-asset solutions at Harbor Capital Advisors, the Federal Reserve's "higher for longer" policy on interest rates "has created downward pressure on capital-intensive parts of the economy that are much more reliant on debt, whether it is related to their business models or consumers taking out debt to drive industrial demand growth."
During an interview with MarketWatch, Lerner said that the industrial sector's inventory buildup that began during the COVID-19 pandemic had held back ordering activity but was close to having worked through the excess inventory.
He also said that the higher interest rates had restricted the housing component of the economy.
Lerner's team manages about $3 billion, while Harbor Capital, based in Chicago, has about $60 billion in assets under management. He co-manages the Harbor Multi-Asset Explorer ETF MAPP, which was launched in September and shifts its portfolio by sector, industry, asset class and geography, using exchange-traded funds to follow a total-return strategy while attempting to reduce downside risk.
Lerner said the projected CAGR for the industrial sector reflected "assumptions that the Fed will begin an interest-rate-cutting cycle that will last for at least a year, with rate cuts of 150 basis points." This would mean a reduction in the central bank's target for the federal-funds rate to a range of 3.75% to 4%, from its current range of 5.25% to 5.50%.
"Rate cuts will cause the industrial part of economy to reaccelerate and catch up to the less debt-levered part of the economy," Lerner said. He pointed to the group of tech companies known as the Magnificent Seven - Microsoft, Apple Inc. $(AAPL)$, Nvidia, Amazon.com Inc. $(AMZN)$, Meta Platforms Inc. (META), Alphabet Inc. $(GOOGL)$ $(GOOG)$ and Tesla Inc. $(TSLA)$, which make up 31.7% of the SPY portfolio - as faring especially well in the high-interest-rate environment.
"We should start to see a bit of a closing of the gap," with companies outside the Magnificent Seven group improving, he said.
Lerner expects the U.S. housing-supply shortage to be an important driver of growth for builders and suppliers of building materials. He also expects increased ordering activity for the aerospace and defense industry, as well as for companies that make equipment that supports the buildout of computing power to support generative artificial intelligence. These include makers of temperature-control systems, energy storage, power switches and security products.
"The challenge is that this is a diverse sector," he said.
Bill Hench heads the small-cap team at First Eagle Investments, which is based in New York and has about $138 billion in assets under management. He co-manages the $1.7 billion First Eagle Small Cap Opportunity Fund FESCX.
When describing the slow ordering activity for industrial companies over the past couple of years, Hench told MarketWatch that people "had their hands in their pockets" because of fear that "a deep recession was long overdue." The negativity also reflected international conflicts, trade disagreements and "the LNG cutoff," he said. That last item refers to the Biden administration's announcement in January that it would pause approvals of new liquid-natural-gas export deals between U.S. producers and certain countries.
But now Hench sees catalysts for industrial spending in the U.S., including a recent court decision in favor of LNG exporters, the prospect of declining interest rates and the AI-related spending on equipment.
He also covered the U.S. housing shortage and even took a positive view on immigration policy, saying that a more efficient set of rules can drive housing and related industrial spending "for a really long time."
Technically, home builders are in the consumer discretionary sectors of the S&P 500 and related indexes managed by S&P Dow Jones Indices, a unit of S&P Global.
But the industrial sector includes "the components that go into it," Hench said, referring to materials and tools, as well as land development, which includes things like road construction, utility systems, drainage and street lighting.
He estimated that housing-related activity contributes between 6% and 10% of U.S. economic output.
He also pointed to the aviation industry, noting that slow development of new aircraft and an aging fleet mean high demand for replacement parts. "Defense spending has been off the charts as well," he said.
Hench named four industrial stocks he holds within the First Eagle Small Cap Opportunity Fund:
Kratos Defense & Security Solutions Inc. KTOS makes drones and various systems for tracking and controlling launch systems and spacecraft. It ranks highest among the four companies Hench mentioned for expected sales and EPS CAGR through 2026.Carpenter Technology Corp. CRS makes various products using titanium, for use in aircraft and for bone surgery, to name two examples. Hench said he had trimmed this position because of an increase in the share price. Modine Manufacturing Co. MOD traditionally made truck radiators but has leveraged its long experience with thermal control systems to make equipment being installed by data centers. This company was recently mentioned by Jim Stoeffel and Brendan Hartman of Royce Investment Partners as part of a group of AI investment alternatives to Nvidia. This is another successful investment that Hench has trimmed because of his value focus - the share price has tripled overt the past year. AAR Corp. AIR provides various aircraft aftermarket services, including parts and equipment leasing. Hench called AAR's management team "good stewards of capital, constantly looking to take advantage" of market conditions. He said the stock was in "a nice sweet spot for a small-cap investor."
Here is a summary of expected CAGR for sales and EPS for the four companies Hench mentioned. All estimates in this article are for calendar years, as adjusted for any companies whose fiscal years don't match the calendar.
Company Ticker Two-year estimated sales CAGR through 2026 Two-year estimated EPS CAGR through 2026
Kratos Defense & Security Solutions Inc. KTOS 9.7% 22.7%
Carpenter Technology Corp. CRS 8.8% 21.1%
Modine Manufacturing Co. MOD 8.5% 20.5%
AAR Corp. AIR 7.7% 16.4%
Source: FactSet
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