Although the industrial sector had a rough year in 2008, there were some sectors,  like conglomerates, rails, and aerospace and defense sub-sectors, that were able to help boost some of the lagging sub-sectors that relied heavily on residential construction and business spending. The net effect was an out performance in the first three quarters of the year. In Q4 2008 and the beginning of 2009, we’ve seen the performance of the Industrials ETF, the XLI (XLI),  significantly underperform the S&P 500 as the more attractive sub-sectors in 2008 began to plummet based on economic factors such as the expected 2010 defense report for the defense sector, and lower volumes for the railroad companies. Since March 9th, stocks are 18% off their recession lows, and some analysts are even bold enough to predict an earlier-than-expected recovery in the second quarter of this year. Whether or not  this is the case, it is time for investors to start thinking about removing some of their defensive holdings and swapping them with ones in the construction and engineering sub-sector, which is extremely likely to outperform the rest of the market on the way up.

Construction and engineering companies saw an early run-up in 2008 as energy prices skyrocketed until the commodities bubble had burst. It then took a deserved beating as businesses curtailed spending to keep up with the decline in consumer expenditure. To do this, the first thing companies wanted to do was to cut their expansionary plans for a rainy day. Construction equities like Flour Corporation (FLR), Jacobs Engineering (JEC ), Foster Wheeler (FWLT), and McDermott Int. (MDR ) were decimated due to the expected cuts in future orders and customers backing out of their contracts, which would kill the companies’ backlog orders. In 2008, the industry showed some resilience and recorded year-over-year double-digit growth in the backlog category, as Flour’s and Jacobs’ backlog orders grew 10.2% and 22.9% respectively.

What has investors worried now is this expected decline in backlog orders is on the verge of taking place.