By Ian Salisbury

The U.S. economy is looking strong. So far, manufacturing stocks haven't reaped much benefit, but that could be about to change.

Manufacturing stocks are regarded as cyclicals -- turning in their best performance when the economy is healthy. Lately, however, they have disappointed. The Industrial Select Sector SPDR, a popular ETF that tracks the sector, returned 17% in 2024, well behind the S&P 500's mark of 25%.

U.S. manufacturing levels c ontracted in 11 out 12 months, according to the Institute for Supply Management's Purchasing Managers Index, or PMI. For December, the index registered 49.3. That was up from November's 48.4, although any number below 50 indicates a contraction.

All the same, with the economy humming along -- just look at Friday's blowout jobs report -- there's room for optimism, according to Wolfe Research analyst Chris Senyek.

Investors spent much of last year uncertain who would win the November elections -- but that question is now resolved. While short-term interest rates aren't expected to decline as sharply as investors once hoped, they are still likely to remain lower than they were over the past two years. At the same time, excess inventory, which companies built up to cope with Covid shortages, is steadily being worked through, Senyek noted in a report last week.

"We expect more balanced goods inventory levels in the economy, solid 2.5% U.S. real GDP growth, and loose financial conditions to push the [PMI] index sustainably over 50 in 2025," he wrote.

Indeed, Covid disruptions could ultimately rebound to benefit U.S. manufacturers. Companies that once touted the benefits of global supply chains, have been having second thoughts. That's helped lead to a surge in large, new U.S. construction projects, noted Fidelity portfolio manager David Wagner in his 2025 outlook for the sector.

"The value of projects announced since 2020 is roughly $1.9 trillion, and only about one-quarter of these have entered the construction phase, which implies that the majority of this work may still lie ahead," he wrote.

What stocks could benefit most? Wolfe argues the answer is so-called short-cycle stocks, which make parts and components that are frequently re-ordered, as opposed to durable large-ticket items. These stocks, which Wolfe highlighted in a stock screen featuring eight names, are most likely to benefit from a broad-based, growth-driven manufacturing expansion.

The recommended stocks include two recent Barron's picks -- conglomerate 3M and aerospace company Parker Hannifin.

3M, which makes consumer goods like Post-Its as well as plenty of industrial products, has been on an upswing, returning 51% in the past 12 months, thanks to a management reset and improving margin picture. Today, the stock trades at 17 times 2025 earnings. While that is a big jump from a P/E ratio of 11 a year ago, it remains cheap relative to the S&P 500, which trades at 21.

Parker Hannifin, which makes components for aircraft and other engines, has also been on a hot streak, up 39% in the past year. It now trades at 22 times forward earnings, but it is remarkably reliable -- with a 30-year track record of growing free cash flow -- and stands to benefit from surging post-Covid air travel.

One pick that hasn't fared as well recently is power tool maker Stanley Black & Decker. A victim of both Covid inventory overhang and Trump-era tariff fears, the stock has declined 15% in the past year. Still, shares look cheap at least than 15 times 2025 earnings. And last month the stock was upgraded to Outperform by Mizuho analyst Brett Linzey.

"While prolonged execution issues during the pandemic hangover...weighed on sentiment and pressured earnings, we believe [Stanley Black & Decker] has turned the corner operationally," Linzey wrote. "Management appears squarely focused on executing the transformation."

Write to Ian Salisbury at ian.salisbury@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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January 14, 2025 02:00 ET (07:00 GMT)

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