All Signs Point To A Big Rally In This Sector


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There's no doubt about it, so far in 2014, the market has been more than a little turbulent. Stocks in most of the major S&P industry groups faltered mightily in January, only to come roaring back in February. Now that we've entered March, many traders are positioning themselves for more volatility on the both the upside and the downside.

During near-schizophrenic conditions such as we've seen so far this year, I try to look at industry groups, as well as individual stocks and commodities, that are positioned to do well but haven't quite kept pace with some of their peers.#-ad_banner-#

In the current market, the Industrial Select Sector SPDR (NYSE: XLI ) fits that bill.

The fund's holdings include stalwart firms from industries such as aerospace and defense, industrial conglomerates, machinery, railroad, and construction and engineering, to name just a few. Its top five holdings are General Electric (NYSE: GE ) , United Technologies (NYSE: UTX ) , Boeing (NYSE: BA ) , Union Pacific (NYSE: UNP ) and 3M (NYSE: MMM ) .

As a group, the industrials have not kept pace so far in 2014, and XLI is up only about 1.7%. That makes sense when you consider that the market has been led higher by the mid and small caps of the Nasdaq and Russell 2000, rather than the blue chips of the Dow Jones Industrial Average. The Nasdaq shows a gain of 4.6% for the year, while the Russell 2000 is up 3.9%. Compare that to the Dow, which is off about 1% year to date.

Yet the relative underperformance among industrials is, I suspect, about to end, and here's why.

First, the chart below shows that XLI recently overcame technical resistance at the previous highs around $52. Shares now trade just under $53, which also means they are not too overextended with respect the 50-day moving average, currently at $51.24. To me, the latest move higher looks like smart money momentum that's just getting started.

XLI Chart

Momentum can be enough to push an individual stock higher even if the fundamental catalysts aren't there, but that's not typically the case with sectors. And it's also not the case with large-cap stocks such as those found in XLI.

So, what are the fundamental catalysts that have me bullish on the sector?

One big catalyst is the recent uptrend in manufacturing. According to the Institute for Supply Management ( ISM ) survey of manufacturing conditions, things are markedly improving. The ISM index was up for the ninth consecutive month in February to 53.2 from 51.3 in January. This bested economists' expectations of 52.3.

As the economy, and particularly the manufacturing sector, improves, so too will the aggregate fundamentals in the industrial sector, which should boost XLI.

The positive fundamentals combined with the momentum buying from fund managers looking to capture some alpha with stocks that have underperformed on a relative basis are good reasons to go long XLI here.

Action to Take -->

-- Buy XLI at the market price
-- Set stop-loss at $48.60, approximately 8% below recent prices
-- Set initial price target at $58.10 for a potential 10% gain in three months

This article originally appeared on
This Sector Looks Like It's About to Make a Double-Digit Run

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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This article appears in: Investing , Stocks

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