Price Action & Performance
Since March the XLI has been in a narrow trading range between $120 and $126. In Mid-July, price finally broke out above the $126 level and, after a brief pull-back has executed a bullish pivot from a higher low to set up for August. Sector internals showed increased strength during July, registering 10 52-wk new highs among its constituents and 0 52-wk new lows. 70% of sector constituents are above their 50-day moving average and 83% are above their 200-dy moving average with both gages the upswing in the near-term. Oscillator work on the RSI and MACD have switched to bullish postures for XLI as well.
At the Industry level we’ve seen improvement as well. Road & Rail stocks are making a near-term bullish reversal relative to the broad market as has the Aerospace & Defense Industry and the Machinery Industry. Longer term leadership like the Electrical Equipment, Building Products and Construction and Engineering Industries have perked up as well and Industrial Conglomerates and Professional Services Industries are also exhibiting outperformance trends vs. the broad market.
Economic and Policy Drivers
We’ve had interesting developments in the near-term concerning sector performance vs. macro trends. Historically, sectors like Materials, Industrials and Energy have benefitted from rising rates and rising commodities prices as tailwinds to coincident sector outperformance. In this cycle, lower rates spurred by bets on dovish Fed. policy have been a positive performance catalyst for those sectors. This presents a dilemma for model-based investors that align with historical trends. Our method incorporates those types of inputs, but our method gives a precedence to current price action at the stock, industry and sector level. As such we are embracing the catalyst of lower rates for cyclical value stocks in this cycle.
On the fundamental side, supply chain issues continue to crimp margins for many industrial businesses. Manufacturing wages have continued their steady climb despite plateauing Industrial Production. Trade policies and Tariffs are adding to uncertainty with the Geo-Political environment continuing to be fraught with tensions around the “Hot Wars” in the Middle East and Ukraine and the ongoing “Cold War” between the US and an increasingly aligned Russia & China. Finally, theoretically salutary policies like the CHIPS and Science Act and the Inflation Reduction Act which have aimed to reduce reliance on the global supply chain have had some lagged effects which have dampened optimism in the near-term. It appears investors are betting on lower rates to spark increased commercial and industrial lending, as well as ameliorating elevated labor and financing costs to set up a ramp for marginal fundamental improvements for the sector moving forward.
In Conclusion
We are remaining long XLI on expectations that the July bounce and rotation into cyclical sectors will have upside follow through on continued discounting of an economic soft-landing scenario. We start August OVERWEIGHT XLI with a +2.53% allocation above the benchmark S&P 500.
Chart | XLI Technicals
- XLI 12-month, daily price (200-day m.a.| Relative to S&P 500)
