Industrials: Stocks Fully Valued Despite Economic Uncertainty; Opportunities Still Exist

The Morningstar US Industrials Index’s year-to-date outperformance relative to the US Market Index narrowed during the third quarter, as concerns about a slowing US economy weighed on cyclical stocks. While we view the sector as fully valued, there are compelling investment opportunities across most groups, particularly in the farm and heavy construction machinery industries. We see the opportunity for new technologies to transform the farming equipment industry, resulting in less cyclicality and higher margins over the business cycle. While agricultural data remains mixed, the US Department of Agriculture forecasts inflation-adjusted farm income will increase by 37% this year, which bodes well for farm equipment manufacturers.

The aerospace and defense industry has realized the most substantial year-to-date stock outperformance relative to the broader market, as healthy demand dynamics persist across both the commercial aerospace and defense markets. We maintain our view that the global commercial aircraft fleet will nearly double over the next two decades, driven by secular growth and the replacement of older, less-efficient aircraft.

Last quarter, approximately 80% of Morningstar-covered industrials exceeded consensus earnings expectations. However, we believe these results did not fully capture the impact of tariffs on cost structures. We anticipate that the second half of 2025 will provide a clearer view of tariff costs across the sector. In our view, firms with strong pricing power tied to intangible assets and/or customer switching costs will be most successful at raising prices to help mitigate tariff costs. Companies are also reducing costs and reorganizing supply chains to minimize the impact of tariffs.

As widely expected by the market, the Federal Reserve lowered its benchmark interest rate range by 25 basis points to 4.00%-4.25%. The market anticipates two more 25-point cuts by the end of 2025 (that is, a target range of 3.50%-3.75%). We expect an environment of lower interest rates will spur construction spending—particularly residential construction, which has been restrained by poor affordability. Firms that manufacture or distribute building products or offer construction services are likely to benefit the most.

Top Industrial Sector Picks

CNH Industrial

• Fair Value Estimate: $21.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Medium

CNH CNH is a global manufacturer of agricultural and construction equipment. In the long run, the firm will face steady if not increasing demand for its solutions to help feed a growing global population. Moreover, margin-rich technology add-ons to its product portfolio will continue improving CNH’s returns and through-cycle financial profile. Though the performance gap versus Deere remains wide, CNH has earned its seat at the table and will benefit from favorable, long-term dynamics in global agriculture markets.

Fortune Brands Innovations

• Fair Value Estimate: $82.00
• Morningstar Rating: ★★★★★
• Morningstar Economic Moat Rating: Narrow
• Morningstar Uncertainty Rating: Medium

Fortune Brands FBIN is a competitively advantaged building products manufacturer with a portfolio of well-established brands, including Moen (plumbing fixtures), Master Lock (security), Therma-Tru (doors), and Fiberon (composite decking). We think Fortune Brands will grow faster than the US residential repair and remodel and new construction markets (weighted for the firm’s exposure to these two markets), especially with its growing mix of connected products (that is, smart plumbing fixtures, leak detection devices, and home security products).

Idex

• Fair Value Estimate: $210.00
• Morningstar Rating: ★★★★
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: Medium

Idex IEX manufactures a wide array of products, ranging from equipment used in DNA sequencing to wastewater pumps to “jaws of life” hydraulic rescue tools. The firm differentiates itself by producing highly engineered products for a variety of niche markets, where it typically holds the number-one or -two market share position. We believe that the long-term growth drivers in the semiconductor and life sciences end markets remain intact. Therefore, we believe investors will be rewarded once the cyclical headwinds subside and Idex returns to more normalized organic revenue growth.