U.S. industrials stocks lag AI rally as valuation pressures create rebound case

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Industrials lag AI rally

Highlights

Since April 14, the S&P 500 Industrials ETF (XLI) fell nearly 3% while VanEck Semiconductor ETF (SMH) surged 33%, reflecting divergence amid AI rally.
Industrials' forward P/E ratio stands at 23 versus the S&P 500's 19 and historic 10-year sector average of 20, heightening valuation pressures and correction risks.
Analysts expect third-quarter earnings and AI-driven growth to improve sector sentiment, with stocks like Axon, Boeing, and United Airlines flagged for highest upside.

Drivers of the sector's recent divergence

As reported by CNBC, the split between industrials and chipmakers widens after mid-April, with the S & P 500 industrials sector ETF up 8.8% for the year through Thursday's close, versus a 64% gain for the VanEck Semiconductor ETF. Since April 14, XLI falls nearly 3% while SMH jumps 33%, highlighting how industrials have decoupled from one of the market's strongest AI trades.

A key obstacle for the sector is valuation. FactSet data show industrials trade at 23 times forward earnings, above the S & P 500 multiple of 19 and above the sector's 10-year average of around 20. At the company level, the gap looks starker, with Caterpillar at a forward price-to-earnings ratio of 28, compared with 18 for Nvidia.

Pressure also comes from weakness in defense stocks and growing scrutiny of data center projects. The iShares U.S. Aerospace & Defense ETF is down 10% over the past three months, while companies tied to data center construction and equipment supply face concerns over energy costs, power needs and community impact. Caterpillar drops 23% over the same period, while GE Vernova and GE Aerospace lose 12% and 13.7%, respectively.

The retreat is amplified by investor positioning. Melius Research says the S & P 500 industrials sector has doubled since the end of 2022, adding $2.6 trillion in market value, with 57% of that increase coming from AI- and aerospace-exposed companies. Bank of America analysts say industrials post their biggest outflows, with four-week average flows at record lows in early September, leaving one of the market's most crowded and expensive sectors more vulnerable to a correction.

Earnings and AI demand support recovery hopes

Nicholas Colas, co-founder at DataTrek Research, says the recent underperformance improves the sector's risk-reward profile and argues industrials should do as well as the market, or better, from here. He expects a potential turn to come with third-quarter earnings and forward guidance next month, especially if companies show strong backlogs and dependable earnings streams.

Colas argues that industrials have historically traded as a lower-valuation group, but the AI buildout gives the sector a new growth driver. In his view, companies linked to the AI theme could earn progressively higher valuation multiples because their existing business base is large enough for new demand to meaningfully lift long-term earnings stability.

DataTrek also expects pressure tied to data center development to ease after the U.S. midterm elections. The firm says long-term demand remains intact and points to the ongoing durability of the U.S. economy, including strong earnings, steady spending and a solid labor market, as support for the group.

For investors seeking exposure, the article points to the XLI ETF as well as individual names with strong analyst backing. Stocks cited from a CNBC Pro screen include Axon Enterprise, Boeing, C.H. Robinson, Howmet Aerospace and United Airlines, with Axon showing the largest implied upside based on average 12-month price targets.

Our earlier coverage of the U.S.-China AI rivalry highlighted how strategic competition is accelerating investment into semiconductors, data centers, and other AI infrastructure. We noted that policy, security, and supply-chain pressures are increasingly shaping investor sentiment around the AI trade, reinforcing why chipmakers and adjacent buildout plays have remained in focus.

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