Industrial Opportunities Beyond US Borders
Why a strong US sector might still benefit from selective international diversification
By: Jacob Gaer
Mar. 5, 2026
US Industrials have been one of the clearest sector stories of 2026. The S&P 500 Industrials index is up roughly 14% YTD through February, while the S&P 500 is nearly flat over the same period (Per S&P Global). Schwab rates Industrials as an Outperform, and the S&P 500 just delivered its fifth consecutive quarter of double-digit earnings growth with Industrials among the leaders at 26% in Q4 2025 (Per BlackRock). Looking forward, the physical infrastructure buildout needed for AI continues to flow capital into the sector, and the current interest rate environment is a positive sign for future growth. Broadly speaking, the fundamental case is strong.
The problem is not the destination, it's the path to get there. Over the past few weeks, Industrials have absorbed two waves of volatility that had little to do with company fundamentals. In mid-February, a logistics tool from Algorhythm Holdings, a former karaoke company with a market cap under $10 million, triggered a broad selloff across trucking and logistics names largely rooted in the recent fears of AI disruption. C.H. Robinson fell nearly 15% in a session, RXO dropped over 20%, and the Dow Jones Transportation Average posted its worst performance since Liberation Day. Analysts noted that the reaction was extreme and not representative of actual risk, but the damage was already done for many portfolios. Then, over the weekend, US and Israeli strikes on Iran escalated into a wider regional conflict. Iran's retaliation hit multiple Gulf states resulting in big transporters like Maersk and Hapag-Lloyd suspending all transit through the Strait of Hormuz.
The point is not that US Industrials are broken. The thesis is intact, especially in aerospace and infrastructure. However, certain corners of the sector, particularly transportation and logistics, are targets of both AI and War risk factors. While opportunities still exist in this market, the volatility in this sub-sector has become harder to ignore, raising a fair question for investors. Are there any worthwhile value propositions in rotating out of riskier US industrials and into international industrial sectors with more structural tailwinds? I think there are two opportunities worth considering.
European Defense
European defense is one of the strongest structural growth stories in international industrials right now. The core driver is fiscal spending, particularly out of Germany, where the historic fiscal package approved in late 2025 created a €500 billion off-budget infrastructure fund and significantly expanded the government's capacity to spend on defense (Per CNBC). Goldman Sachs expects German defense spending to reach 3.3% of GDP by 2029, and early data supports it. Factory orders related to defense industries surged in late 2025, and the number of suppliers entering the defense sector continues to grow as automotive and machinery companies shift operations to target the rise in defense demand (Per OSW Centre). Importantly, this spending is not limited to German companies. European defense supply flows across borders, meaning names like BAE Systems, Leonardo, and Thales stand to benefit alongside German contractors like Rheinmetall.
The concern is that most of this is already priced in. The STOXX Europe Targeted Defence index is up over 45% in the last twelve months, and the sector now trades at roughly 30 times forward earnings, about double its five-year average (Per European Business Magazine). The Iran escalation this past weekend also pushed several names to all-time highs. At a sector level view, this looks like a crowded trade, but at the stock level, there is more opportunity than first meets the eye. Morningstar still rates Rheinmetall, Germany's largest defense contractor, as undervalued with a fair value estimate well above where the stock trades today. Others like Thales and Dassault Aviation are also trading below analyst fair value estimates, while names like Saab are likely well overvalued. This opportunity requires careful selectivity based in structural growth and fundamentals.
One negative report recently released on the story further proves the longer-term case here. Goldman Sachs noted that execution on Germany's defense budget will fall short of the ambitious targets this year, simply because the ramp-up is too large for companies to absorb all at once. However, this does not weaken the thesis. It means that spending will take longer to flow through the sector, extending the growth story across multiple years rather than being concentrated within a single cycle. The money is committed through multi-year contracts, and what is not absorbed in year one adds to the backlog for years two through five. For patient investors, this creates a more durable earnings story than a one-time spending hike. Given the current environment regarding conflict with Iran, the best entry point may come on a correction. Likely events that could trigger a correction include surprising peace negotiations, or a quarter where execution disappoints expectations. Either way, the spending is structural and the timeline is long, and that is what gives this trade real value.
Japanese Industrials
Japan is the quieter story, but it may be the deeper one. The Nikkei hit 59,000 for the first time in late February, and MSCI Japan Industrials returned over 42% in the trailing twelve months through January (Per MSCI). Unlike the defense trade in Europe, the rally in Japan is built on a structural shift in how companies operate and return value to shareholders. KKR's Henry McVey spoke on CNBC's Closing Bell Overtime Tuesday of this week, reaffirming high conviction in Japan, which is consistent with KKR's published view that the opportunity in international markets is as robust as they have seen in years.
The core of the thesis is corporate governance reform. Japanese companies have historically hoarded cash, and the market's valuation reflected it. The Tokyo Stock Exchange has been pressuring listed companies to improve capital efficiency since 2023, and 2026 is the year the pressure turns into consequences. The TSE will begin delisting companies that have not made sufficient improvements, and a revision to Japan's Corporate Governance Code expected by mid-2026 will focus specifically on how companies deploy cash and retained earnings (Per Invesco). The results from this effort are already showing in Japanese markets. Janus Henderson reports that dividends are set to increase for a fifth consecutive year and share buybacks have surged in recent quarters. These changes are reinforced by broader economic momentum, with Japan finally showing signs of exiting deflation as rising wages and stronger domestic consumption support the macro level of this investment.
For an industrial-focused portfolio, Japan is also a useful complement because its industrial base looks different from the US. Where S&P 500 Industrials lean toward aerospace, defense, and logistics, Japan is concentrated in machinery, factory automation, and precision manufacturing. Adding Japanese industrial exposure diversifies what you own, not just where you own it, and that distinction matters when the biggest risks in US Industrials are concentrated in transportation and logistics.
Closing Takeaway
None of this is an argument to step away from US Industrials. The sector's fundamentals are strong, earnings growth is real, and names in aerospace and infrastructure are well positioned for 2026. But for investors who are already positioned here, selectively diversifying toward European defense and Japanese industrials offers a way to stay in the sector while adding structural tailwinds that are less exposed to the specific risks weighing on the US side of industrials.
