High oil prices and the decline of AI trading are squeezing the industrial sector of U.S. stocks, which is undergoing a momentum liquidation.

In the past three weeks, U.S. industrial stocks, which had previously been on a strong upward trajectory, suddenly faced a momentum reversal, leading some investors to anticipate greater pressure in the market ahead. Since hitting a record high on August 14, the S&P 500 industrial sector index has fallen by 6.1%. The renewed conflict in Iran has pushed oil prices higher, while the AI trading frenzy has begun to wane, both dragging down the sector's performance. Technical alarm signals have started to flash. This round of selling has pulled the index below its 50-day and 100-day moving averagesthese averages measure short-term and medium-term price trends, respectively. Brian Malbery, Chief Market Strategist at Zacks Investment Management, stated, Falling below these moving averages could likely intensify downward momentum in the short term. He further pointed out that the index may next test the 200-day moving average, a key support level, which still has about a 2.5% downside potential from current trading levels. Malbery attributed this sell-off to the collapse of momentum trading strategies that had previously driven the sector up, while others on Wall Street pointed to macroeconomic factors. Due to ongoing disruptions in shipping through the Strait of Hormuz, oil prices have regained upward momentum, and inflation expectations and long-term bond yields remain high. This "unfavorable combination" could not only increase production costs and raise financing costs for capital-intensive manufacturing companies but could also impact the overall economic demand that supports their sales. To make matters worse, the valuation of the industrial sector has soared to approximately 23.7 times the expected earnings for the next 12 months, significantly higher than the overall S&P 500's 19.4 times price-to-earnings ratio. Brian Spenheim, a portfolio manager at Gabelli Funds, remarked, This sets the stage for a pullback. If youre a trader, the path of least resistance right now is to hit the sell button. However, there are signs that many investors have preemptively sold off, suggesting that the steepest declines may have already passed. A report from Bank of America Corp last week indicated that its clients have exhibited surrender selling, with reductions in the industrial sector holdings reaching the highest level since 2008. Meanwhile, the fundamentals still appear solid, implying that the decline over the past three weeks may ultimately be a brief correction rather than the beginning of a deeper downturn. The large industrial stock index is up 13% this year to date, continuing last year's 18% gain. On the economic data front, U.S. manufacturing activity expanded for the eighth consecutive month in August, although the pace of expansion has slightly slowed. However, like many sectors in the stock market, the final direction of industrial stocks may still depend on the continued enthusiasm for AI tradinga theme that has been a significant engine for the sector. Tech companies are spending hundreds of billions on data center construction, generating strong demand for generators, electrical equipment, and construction machinery. That said, recent transactions in AI infrastructure have shown signs of fatigue. Since early July, concerns about data center capital expenditures potentially falling short of overly high expectations have prompted traders to sell off shares in chip manufacturers and power equipment companies. Mark Hackett from Nationwide noted that resistance to data center construction has also heightened selling pressure. Gas turbine giant GE Vernova (GEV.US) and electrical equipment manufacturer Eaton Corp. Plc (ETN.US) have both dropped at least 9% since August 14, becoming major stocks dragging down the industrial index; Caterpillar Inc. (CAT.US) has also fallen 5%. Miller Tabak Chief Market Strategist Matt Maley noted that industrial giants like Caterpillar have long been viewed as bellwethers for the overall market, and their deep ties to the AI supply chain have reinforced this importance. "If the weakness in this sector persists, it should raise widespread caution among investors," Maley stated. The transportation sector is under pressure, while agricultural machinery shows glimmers of hope. Since the last record high, GE Aerospace (GE.US) and Raytheon Technologies (RTX.US) have also been major detractors from the index. Since mid-August, oil prices have risen by over 10%, putting pressure on jet engine manufacturers and airlines with high fuel consumption. Freight transport stocks have similarly struggled due to high oil prices and elevated interest rates. Meanwhile, investors in truck transportation companies like Knight-Swift Transportation Holdings (KNX.US) are worried about the declining rates charged to customersa troubling signal just as truck rates were beginning to rebound after years of stagnation. Citigroup analyst Ali Raza remarked, Our core question is whether this reversal is temporary? He pointed out that if truck rates ultimately underperform, the impact on corporate earnings could be quite profound. Agricultural equipment manufacturers are among the few bright spots. Rising prices for crops such as wheat and soybeans typically mean increased income for farmers, which can then be used to purchase tractors and other equipment. This trend has bolstered the stock prices of Deere & Company (DE.US) and its peers, prompting analysts to raise their ratings. For now, other industrial stocks remain constrained by an unfavorable macro environment. However, Jonathan Golodoff from CFRA indicated that metrics like profit margins and orders at the corporate level remain robust, and he expects investors will find relief when the upcoming earnings season arrives. Analysts predict that the sector's earnings growth for the current period is expected to accelerate from 13% in the second quarter to nearly 19%, while growth for the full year 2027 is expected to exceed 17%. Golodoff stated, In the short term, market sentiment may indeed experience more volatility. But we believe that when the outlook for the third and fourth quarters emerges, particularly when the 2027 earnings guidance starts to come out, these short-term disturbances will be digested by the market.