Deteriorating economic data has weighed on XLI shares, but breadth is nearing wash out levels. We are beginning to suspect the negative news has been priced in, making the XLI a likely candidate to positively surprise us in July.
Price Action & Performance
XLI price is at intermediate terms support on the chart as it continues its current multi-month consolidation. June ended with a bit of a bearish blow-off to the downside and internal indicators show breadth (% of stocks above their 50-day moving average) nearing the historical “buy zone” for the reading. At the GICS Industry level, leadership groups like Building Products, Electrical Equipment and Construction & Engineering sold off in June without a concomitant bullish reversion in laggard sectors. On the positive side of the ledger, Road & Rail stocks are showing some 2nd derivative improvement, and the Air Freight Industry has shown signs of bullish reversal along with the Commercial Services Industry.
While price action and performance remain weak in a vacuum, the reasons for positive allocation in the Elev8 model have more to do with context. XLI has more ways to win in the current environment than the XLB does and has entered this near-term period of weakness with more industries in longer-term outperformance trends. The Dow Transportation Average triggered a tactical buy signal in June and Crude prices and Yields have firmed during the month as investors discount a higher probability of dovish monetary policy going forward. Rates were volatile in June, but the US 10yr Yield remains in a long-term consolidation between 3.7%-5% and the momentum signature of the pattern is distributional, despite the near-term upswing.
Economic and Policy Drivers
Inflation is a dominant theme across all sectors, but with very different implications. XLI outperformance would likely be driven by a hotter inflation prints in the 2nd half of 2024, but that is not the way the trend looks to be going at this point in the cycle. Instead, investors have shifted to expectation of interest rate policy easing as economic data has generally come in below forecast during May and June. Supply chain issues continue to add marginal costs and 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.
How Can XLI Help?
XLI is a powerful tool for Industrials investing. It provides an extremely cost-effective way to get the very broad exposure the sector offers all in one instrument. If this month’s inflation print is hot, Sanitation services like RSG and WM, as well as Machinery plays like CAT and DE should benefit. Investors might also find the fixed government contracts of RTX, GD and LMT etc. attractive. If inflation comes in cool, there are several areas of the sector that respond positively to lower rates as well like Building Products which ties into the lack of supply that has been driving homebuilders and home price appreciation. Airlines would likely do well if inflation eases, and the consumer gets some confidence. There are also several AI plays in the sector like ETN and PH which have benefited from the enormous NVDA halo over the last 12+ months.
In Conclusion
We are remaining long XLI as it is deeply oversold near-term and tactically attractive if we see profit taking from L/T winning sectors XLK and XLC. Our Elev8 Sector Rotation Model grades on a curve and XLI has again made the cut for inclusion. We start July OVERWEIGHT XLI with a +1.87% allocation above the benchmark S&P 500.
Chart | XLI Technicals
- XLI 12-month, daily price (200-day m.a.| Relative to S&P 500)
- Price has near-term support at the $120 level. RSI is oversold with MACD flattening out near the zero line. There is potential for a bounce as oversold conditions are unrelieved.
