Industrials: An AI beneficiary with broader catalysts

January 21, 2026

Magdalena Ocampo

Market Strategist

Finding opportunity and diversification in an AI-driven market

AI bubble concerns have intensified as billions of dollars are pouring into AI infrastructure, and companies are turning to debt financing to fund their capex ventures. However, there are fundamental differences between today’s AI rally and past bubbles, notably the dot-com era, that should temper those fears for now. Still, valuations are elevated, and the S&P 500’s concentration, along with the tech, communication services, and consumer discretionary sectors, is heavily skewed by the dominance of the Magnificent 7.

Given the strong run-up in the Mag 7, finding an entry point at reasonable valuations has become increasingly challenging. These companies continue to deliver strong earnings quarter after quarter, and a favorable macro backdrop is likely to persist through 2026, intensifying the entry-point challenge. Therefore, sector diversification and strategies aimed at identifying segments with lower valuations, but supportive tailwinds, could be prudent.

One sector that stands at an interesting intersection—a direct and indirect beneficiary of AI, offering diversification and multiple drivers beyond AI—is Industrials. Traditionally viewed as an economically sensitive sector, Industrials managed to outperform the broader S&P 500 last year despite weak housing, sluggish manufacturing activity, and a softer labor market. Performance within the sector was mixed, however, reflecting a collision between long-term structural and shorter-term cyclical drivers.

2025 price performance by industry in the Industrials sector

Industry	2025 Price Return	Weight of Industrials
Aerospace & Defense	39.9%	28.1%
Construction & Engineering	28.8%	2.8%
Electrical Equipment	26.9%	10.6%
Machinery	21.1%	20.1%
Passenger Airlines	16.7%	2.0%
Ground Transportation	15.2%	9.5%
Trading Companies & Distributors	7.2%	3.0%
Building Products	4.2%	5.3%
Industrial Conglomerates	2.1%	4.4%
Commercial Svcs & Supplies	-0.8%	5.3%
Air Freight & Logistics	-3.3%	3.7%
Professional Services	-10.7%	5.5%

Source: Bloomberg, Principal Asset Management. Data as of December 31, 2025.

The key structural drivers—AI infrastructure growth, rising defense spending, and a global aerospace production backlog—will likely continue to support Industrials ahead. A more constructive macro cycle this year could lift lagging cyclical industries, potentially broadening the sector’s rally if tailwinds align. The gains could be magnified if AI adoption boosts productivity and cuts operational costs for companies in the sector.

The structural drivers: AI infrastructure, defense budgets, aerospace backlogs

AI infrastructure: AI’s growing infrastructure demands, specifically data center buildouts, create investment opportunities beyond tech. Industrial companies in the construction & engineering, electrical equipment, and construction machinery equipment industries (~22% of the sector) supply critical components for data centers, from electrical design to cooling systems and battery storage.

Some estimates suggest that global data center investment could reach $7 trillion by 2030 to meet surging power needs, largely driven by AI workloads. Supply constraints, such as reliable power availability and skilled labor shortages, are slowing data center buildouts, reducing the risk of overcapacity and supporting pricing power. Although it is also worth considering that generative AI training buildouts are more speculative and, in some markets, contribute to near-term oversupply. As a result, the sustainability of the buildout also hinges on where the spending is directed.

Companies within these industries also stand to benefit from investments in and upgrades to the power grid. Roughly half of U.S. active transformers are reaching the end of their useful life, adding indirect exposure to AI infrastructure demand.

Increased defense spending: Data center growth is not the only structural driver behind Industrials. The geopolitical landscape is adding another layer of strength, with the aerospace & defense industry (~25% of Industrials) benefiting from rising government defense budgets.

Ongoing geopolitical conflicts have reinforced the need for governments to bolster and modernize their defense capabilities. All 32 NATO members are projected to meet the 2% defense spending target as a share of GDP in 2025 for the first time, and nearly all agreed to raise their target to 5% of GDP by 2035 in this summer’s annual summit.

Even if geopolitical tensions ease or defense spending falls short, the need to replenish missiles and modernize aging inventories remains an important driver of sustained demand.

Aircraft order backlogs: In addition to defense, aircraft producers benefit from strong post-pandemic demand and order backlogs that extend well into the next decade, supporting sustained production volumes. While commercial air travel is cyclical and sensitive to consumer demand, several long-term factors point to a sustainable expansion in aircraft demand that can offset cyclical shifts.

Demographics: Rising global populations and increasing income levels support long-term travel demand. Global travel is projected to grow ~3.5% annually over the next decade, outpacing the global economy’s expected growth of 2.7%-2.9% through the early 2030s.
Supply constraints: Aircraft manufacturers continue to receive sizable orders, and airlines are unlikely to cancel orders, even if consumer demand were to soften, given production backlogs potentially stretching to a decade.
Fleet modernization: A retiring of older aircraft for more fuel-efficient models, an effort that is expected to reduce operating costs as jet fuels make up ~30% of airlines’ operating expenses, is likely to keep demand steady. Margin gains could further offset tariff headwinds, which have remained contained.

Cyclical drivers to watch in 2026 for a broader Industrials rally

Industries more vulnerable to cyclical shifts, nearly half of the Industrials sector, have lagged as 2025’s macro headwinds hindered a revival in key economic indicators.

This year monetary easing, supportive fiscal policy (including tax cut extensions and deregulation), easing trade uncertainty, and robust AI-driven spending could provide a more constructive backdrop for economically sensitive segments of the market.

Industries tied to real estate (building products), manufacturing (industrial machinery, environmental & facilities services), employment (HR services), and consumption (transportation) stand to benefit—particularly those trading at a discount to the Mag 7 or the mega cap universe, as an improvement in earnings momentum could set the stage for stronger rallies.

Industrials’ adoption of AI is increasing productivity

From a macro perspective, both structural and cyclical drivers support continued gains for Industrials, and potentially stronger performance if they align. A third factor could add further upside: the ability of these companies to adapt to an AI-driven environment by integrating AI into their operations.

The big debate for investors is whether AI will deliver on its promises and whether productivity gains will translate into earnings growth. There is no clear answer, and this debate will likely intensify as markets try to separate promises from actual results.

A recent St. Louis study tracking Gen AI adoption and productivity gains by industry revealed that technology is reshaping work and delivering tangible time savings. This extends to the Industrials segment, where several industries—transportation & warehousing, construction, and manufacturing—are reportedly seeing productivity gains. One specific example of AI-driven efficiencies translating into tangible value is a transportation leader using AI to address trucking inefficiencies, resulting in a 50% improvement in scheduling times and a 24% reduction in appointment costs.

Implications for investors

From a macro perspective, Industrials offer a way to gain AI exposure at more reasonable valuations than the broader tech sector, albeit with variation across companies, while adding meaningful diversification. Structural tailwinds—including the AI infrastructure buildout, rising defense budgets, and sustained commercial aircraft demand—support continued momentum. Should monetary easing and supportive fiscal policy revive broader economic activity this year, the more cyclical parts of the sector would likely participate, extending market leadership beyond the narrow group that dominated in 2025.

At the company level, active selection remains essential to finding true outperformance opportunities. AI-driven productivity gains will not be uniform, and investors may benefit from focusing on firms applying AI to streamline operations, enhance decision-making, and expand margins.

Ultimately, Industrials offer a compelling avenue for investors to capture the next wave of innovation beyond traditional tech, with meaningful opportunities emerging across the market cap spectrum as AI adoption accelerates.

Equities

Macro views

According to McKinsey in “The cost of compute: A $7 trillion race to scale data centers” by Jesse Noffsinger et al., April 2025.

According to National Laboratory of the Rockies in their study on transformer demand growth through 2020 by Tim Meehan, December 2024.

NATOs’ Defense expenditures and NATO’s 5% commitment, June 2025.

According to World Travel & Tourism Council’s (WTTC) 2025 Economic Impact Research (EIR).

According to the OECD’s global long-run economic scenarios: 2025 update.

According to the International Air Transport Association (IATA) on fuel efficiency in aviation, May 2025.

Federal Reserve Bank of St. Louis, The State of Generative AI Adoption in 2025, Alexander Bick et al., November 2025.

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