An under-the-radar market signal suggests industrial stocks are about to surge

• There's an under-the-radar market signal that suggests industrial stocks are about to soar.
• Fundstrat highlighted that credit default swaps tied to the sector have been outperforming the broader market.
• "This is a sign that credit investors see relatively decreasing risks in Industrials," Fundstrat's Tom Lee said.

Industrial stocks could be on the verge of a big move higher based on an under-the-radar market signal, according to Fundstrat's Tom Lee.

In a Wednesday note, he highlighted to clients that credit default swaps tied to the industrial sector have been outperforming the broader CDS market considerably since September.

"This is a sign that credit investors see relatively decreasing risks in Industrials. CDS tends to be a relatively liquid and good measure of credit risk for a company" Lee said.

It's also a sign that industrial stocks could be poised to significantly outperform the S&P 500 going forward.

Lee tracked the relationship between industrial CDS performance with that of industrial stocks relative to the S&P 500 and found that CDS are a leading indicator for equities about three months into the future.

"Industrials CDS moves tend to lead Industrial equities by 90 days. Thus, this suggests that we should see relatively improving performance soon," he predicted.

The improving outlook for the industrial sector's CDS coincides with a rebound in manufacturing activity, evidenced by this week's release of the S&P Flash US PMI survey, which hit 50.0, representing one of its best readings since October 2022.

A reading above the 50 level signals that manufacturing activity is growing, while a reading below that level signals that manufacturing activity is contracting. The PMI had been below 50 throughout most of 2023.

"PMIs look to be in a bottoming process," Lee said, and that bodes well for industrial stock prices, historically.

"Since 1950, when PMIs are rising and still below 50, industrials gain 95% of the time over the next 12 months, with a median gain of 21.5%," he added.

Fundstrat has an "Overweight" rating on the industrials sector. Some of the biggest companies within that sector include Union Pacific, Caterpillar, Honeywell, General Electric, and United Parcel Service.