Are industrials losing steam?

New doubts about the stability of the economic recovery and the demand for the products and services that were supposed to fuel it have taken a visible toll on the industrial sector. That sentiment has been building since May but seemed to come to a head during Tuesday s selloff, when Boeing (BA) and Caterpillar (CAT) were among the loss leaders on the on the Dow Jones Industrial Average. The industrials sector of the S&P Global 1200 index fell 3.5% for the day and helped weigh down the broader index (-3.2%).

Now, investors who had banked on demand for the items rolling off the world s assembly lines face a choice: bet that the recovery rights itself and demand returns or cut their losses and look for a safer sector.

Market watchers say industrials have been hurt by an adjustment of global expectations. The sector is suffering as the world reevaluates its prospects for growth, especially in China, says Paul Nolte, managing director of Dearborne Capital Management.

On Monday, the Conference Board revised its index of leading economic indicators for China for April down to 0.3%, from a prior estimate of 1.7%, spurring more concern about growth in an area some industry watchers had speculated would lead the world out of economic decline.

European economies offered little solace. On Tuesday, the European Central Bank came up short on bids at a weekly sale of short-term notes intended to absorb liquidity; European governments expanded the cast of banks that should be subjected to stress tests; and Greece faced protests over its austerity plans, which includes steep cuts to pension benefits.

And over the weekend, members of the Group of 20 major economies pledged to cut their annual deficits in half by 2013, a promise that could weigh on industrials that rely on government spending.

The world changed quickly for industrials. Only three months ago, the sector was a market leader. A steady flow of government stimulus money and improving economic data had suggested to many investors that industrials had plenty of running room. In April, Dow components like General Electric (GE), Caterpillar, Boeing and United Technologies (UTX) outperformed the broader benchmark index for the year-to-date by wide margins.

Industrials were supposed to be leading the recovery, says Doug Roberts, chief investment officer at Channel Capital Research. They were the group that would have benefitted the most from a V-shaped recovery, but if the recovery turns out to be more U-shaped or L-shaped (in other words, if it takes longer), they re the ones that will suffer the most, he says.

Industrials have not fallen off a cliff yet. As of Tuesday s close, the industrials sector of the S&P 1200 Global index boasted the smallest year-to-date loss of any component sector just 4.1%. However, its strength has been waning over the past few weeks, as investors have turned to more mundane utilities, health care and nondurable goods that typical offer slower growth but more consistent earnings.

Investors could return to industrials, Nolte says, citing patterns in similar market declines from 2000 through 2003 and again in 2008. Once it becomes clear -- or at least appears to be so -- that the economy is picking up steam, these names will once again move to the head of the class, he says.

The question for investors is how long that might take. The two long-term drivers of a domestic recovery job growth and consumer spending seem to be fueled more by the government today, says Roberts. Now, it appears an Act 2 isn t on the way, at least not before the U.S. elections, he says.

To be sure, there s still a lot of stimulus money already approved and yet to be spent, but the market is a discounting mechanism and is already looking beyond that funding, Roberts says, adding that even if the U.S. were to promise a continued stimulus, the rest of the world has signaled it is not on board.

In the near term, industrials could see a slight bounce, pending a string of economic data including the June jobs report scheduled to be released later in the week. Roberts says a lot could be riding on that data. If you don t have a bounce, a lot of people could throw in a towel, he says.