Every Wednesday, Marc Chaikin applies his groundbreaking analysis to an ETF or a sector. Today, he looks at Industrial Select SPDR ETF (XLI).
The Industrial Sector has been underperforming the overall stock market since mid-June as it broke its Chaikin long-term trend line. It triggered a relative strength sell signal in on Jul 16th at 54.64. The Industrial Sector is a mixed bag of transportation, machinery, aerospace and manufacturing companies. Because of that diverse group mix, the XLI cannot be easily analyzed by just looking at the underlying component stocks in the Sector.
Adding additional complexity is the fact that many of the component stocks generate a significant portion of their revenue from international markets and are thus subject to the influence of the U.S. Dollar vs. the Euro currency swings. Currently the U.S. Dollar has broken out of an intermediate term downtrend and will soon test a triple top area.
The strength in the Dollar vs. the Euro has had a negative impact on companies like Caterpillar (CAT), MMM Corp (MMM), Raytheon (RTN) and Rockwell Collins (COL), all of which have begun to break down technically.
The flip side of the strength in the U.S. Dollar is that industrial companies that derive the majority of their revenue from domestic activity such as domestic airlines, trucking and railroad companies are performing well in the current environment and have recently made new highs. Reflecting the overall strength in the U.S. economy and reporting record earnings in cases such as Southwest Airlines and Ryder Systems (R), these stocks are the attractive investment opportunities in the Industrial sector.
Rather than treat this underperforming sector as a short side trading vehicle, my recommendation is to use a tool like our Portfolio Health Check to zero in on the strongest and weakest stocks in the XLI and trade on the right side of the market.
This is one instance where the sum of the parts is clearly less than the whole.
This relative strength in the Industrial Sector, led by Airlines, Trucking and Railroad stocks reflects the overall strength in the U.S. economy. Two key economic metrics highlight this strength. Rail traffic has reached new 3 year highs with recent July reports indicating a 10% year over year increase in rail car loadings. The second economic number which points to an improving U.S. economy is the low level of jobless claims which now stands at a 5 year trough. In spite of the cautious naysayers, the action of the Transportation industry confirms that the economy is strong and growing.
The Chaikin Power Bar below indicates that 8 stocks in the XLI have a bullish Power Gauge rating while 9 have a bearish rating.
With the strength in the Transportation group likely to continue, the simple way to profits in the Industrial stocks to buy the strongest stocks in the XLI, based on their Chaikin Power Gauge rating
, preferably on short-term pullbacks. These stocks are likely to outperform the market and the XLI ETF itself.
Portfolio Health Check is an excellent tool to help zero in on the strongest stocks in any ETF and since the SPDR S&P Industrial ETF (XLI) is a mixed bag of strong and weak industry groups, it is the most effective way to find profitable stocks in the XLI.
By looking at the individual component stocks through the lens of the 20 factor Chaikin Power Gauge rating, you can easily find the stocks in this outperforming ETF with the strongest potential over the next 3-6 months. These are the stocks to consider buying as this weak sector has recently broken its pattern of higher highs and higher lows dating back to February. Of course, if you follow the discipline of only buying strong stocks in strong sectors, the Industrials (XLI) may be one to avoid altogether; but, if you want exposure to this sector look for the stocks with the strongest potential based on the Power Gauge rating
The Chaikin Power Grid (see below) maps stocks and industry groups from strong to weak so you can easily determine the best and worst stocks in any ETF. To find the strongest stocks in the XLI, we look to the upper right quadrant of the Power Grid (strong Power Gauge stocks) where we find stocks with the best potential for price gains over the next 3-6 months.
Our favorites in this ETF include Southwest Air (LUV), CSX Corp (CSX), Ryder Systems, Snap-On Inc. (SNA) and Union Pacific (UNP). Ryder and Snap-On made a new high last Friday while in the Railroad group, CSX Corp. and Union Pacific spiked up to new highs recently and show strong institutional buying based on the Chaikin Money Flow indicator. These stocks are all pulling back in a soft market and may provide long entries on weakness over the next few days.
Over time, strong stocks in strong industry groups will outperform weak stocks in weak groups.
One stock to avoid in the weak Aerospace – Defense group is Rockwell Collins which recently triggered a Relative Strength Sell signal in Chaikin Analytics at 80.43 and closed last night at 74.22 (see chart).
Chaikin Portfolio Health Check
Nasdaq Chaikin Power Indexes