High oil prices and the retreat of AI trading are squeezing the industrial sector of the U.S. stock market, which is experiencing a momentum liquidation.

In the past three weeks, U.S. industrial stocks, which had previously been on a rapid rise, suddenly faced a momentum reversal, leading some investors to anticipate greater pressure in the market ahead. Since reaching an all-time high on August 14, the S&P 500 industrial sector index has fallen 6.1%. The resurgence of oil prices due to renewed conflict in Iran, combined with a cooling off in the artificial intelligence (AI) trading frenzy, has collectively dragged down the sectors performance. Technical warning signals have begun to flash. This round of selling has pulled the index below both the 50-day and 100-day moving averages, which respectively measure short-term and mid-term trends in stock prices. Brian Marber, Chief Market Strategist at Zacks Investment Management, stated, Falling below these moving averages is likely to exacerbate downward momentum in the short term. He further pointed out that the index may soon test the 200-day moving average, a key support level, which is approximately 2.5% below current trading levels. Marber attributed the sell-off to the disintegration of momentum trading strategies that previously propelled the sector upwards, while others on Wall Street have pointed to macroeconomic factors. With shipping in the Strait of Hormuz still hampered, oil prices have resumed their upward trend, keeping inflation expectations and long-term bond yields elevated. This negative combination could not only inflate production costs and raise financing costs for capital-intensive manufacturing companies but also impact the overall economic demand that supports their sales. To make matters worse, the valuation of the industrial sector has surged to about 23.7 times expected earnings over the next 12 months, showing a significant premium compared to the S&P 500s overall price-to-earnings ratio of 19.4 times. Brian Spengler, a portfolio manager at Gabelli Funds, remarked, This lays the groundwork for a pullback. If you are a trader, the path of least resistance right now is to hit the sell button. However, there are also signs that many investors have already preemptively sold off, suggesting that the most severe declines may have passed. A report from Bank of America Corp last week indicated that its clients have exhibited surrender-style selling, with reductions in the industrial sector reaching the highest level recorded since 2008. Meanwhile, the fundamentals still appear robust, suggesting that the pullback over the past three weeks may ultimately be a brief correction rather than the start of a deeper decline. The large industrial stock index has accumulated a 13% increase so far this year, continuing last years 18% gain. On the economic data front, U.S. manufacturing activity has expanded for the eighth consecutive month, although the pace of expansion has slightly slowed. However, like many sectors in the stock market, the ultimate direction of industrial stocks may still depend on the heat of AI tradingan important engine for the sector previously. Technology companies are investing hundreds of billions in building data centers, creating a strong demand for generators, electrical equipment, and construction machinery. Yet, recent AI infrastructure deals have shown signs of fatigue. Since early July, concerns over whether data center capital expenditures will meet overly high expectations have led traders to sell off semiconductor manufacturers and electric equipment stocks. Mark Hacket of Nationwide pointed out that public resistance to data center construction has also added to the 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 laggards in the industrial index; Caterpillar Inc. (CAT.US) has also declined by 5%. Matt Maley, Chief Market Strategist at Miller Tabak, noted that industrial giants like Caterpillar have long been seen as barometers for the overall market, and their deep ties to the AI supply chain have further reinforced this importance. If the weakness in this sector persists, it should raise broad caution among investors, Maley stated. The transportation sector is under pressure, while agricultural machinery shows signs of recovery. Since the last historical peak, GE Aerospace (GE.US) and Raytheon Technologies (RTX.US) have also become major detractors in the index. With oil prices rising over 10% since mid-August, jet engine manufacturers and fuel-hungry airlines face downward pressure. Freight transportation stocks are similarly performing poorly due to high oil prices and interest rates. Meanwhile, investors in trucking companies like Knight-Swift Transportation Holdings (KNX.US) are concerned about declines in rates charged to customersthis concerning signal comes just as truck rates had recently rebounded after a prolonged downturn spanning several years. Citigroup analyst Ali Raza said, Our core judgment is to determine whether this reversal is temporary. He pointed out that if truck rates ultimately perform disappointingly, the impact on corporate profitability could be quite profound. Agricultural equipment manufacturers are among the few bright spots. Soaring prices for crops like wheat and soybeans typically mean increased income for farmers, which can translate to purchases of tractors and other equipment. This trend has boosted the stock prices of Deere & Company (DE.US) and its peers, prompting analysts to upgrade their ratings. For now, other industrial stocks remain constrained by an unpromising macro environment. However, Jonathan Gallop of CFRA noted that corporate-level indicators such as profit margins and orders remain strong, and he expects investors to find a reprieve when the next earnings season comes around. Analysts predict that earnings growth for the sector during this period is expected to accelerate from 13% in the second quarter to nearly 19%, with growth for the full year of 2027 expected to exceed 17%. Gallop stated, In the short term, market sentiment may indeed experience more volatility. But we believe that when the third quarter and even fourth quarter outlooks are released, especially as 2027 earnings guidance starts to come out, these short-term disturbances will be absorbed by the market.