My methodology when analyzing a sector-specific ETF is to first look at the economic backdrop of that sector. I then look at the charts of the ETF to determine if it's an appropriate time to go long (if the sector is expanding) or go short (if the sector is contracting).
The Institute for Supply Management®, ISM®, and PMI® are all registered trademarks of the Institute for Supply Management. The author has written permission to use the current month’s report on file.
Investment thesis: the economic backdrop is strong. However, the ETF is in the middle of some modest profit-taking. Hold-off for now. If you already have a position, keep it.
Today, there were two PMI releases. The first was from The Institute for Supply Management®, which contained the following data summation (emphasis added for emphasis):
“The June Manufacturing PMI® registered 60.6 percent, a decrease of 0.6 percentage point from the May reading of 61.2 percent. This figure indicates expansion in the overall economy for the 13th month in a row after contraction in April 2020. The New Orders Index registered 66 percent, decreasing 1 percentage point from the May reading of 67 percent. The Production Index registered 60.8 percent, an increase of 2.3 percentage points compared to the May reading of 58.5 percent. The Prices Index registered 92.1 percent, up 4.1 percentage points compared to the May figure of 88 percent and the index’s highest reading since July 1979 (93.1 percent). The Backlog of Orders Index registered 64.5 percent, 6.1 percentage points lower than the May reading of 70.6 percent. The Employment Index registered 49.9 percent; 1 percentage point lower compared to the May reading of 50.9 percent. The Supplier Deliveries Index registered 75.1 percent, down 3.7 percentage points from the May figure of 78.8 percent. The Inventories Index registered 51.1 percent, 0.3 percentage point higher than the May reading of 50.8 percent. The New Export Orders Index registered 56.2 percent, an increase of 0.8 percentage point compared to the May reading of 55.4 percent. The Imports Index registered 61 percent, a 7-percentage point increase from the May reading of 54 percent.”
The index uses 50 as the dividing line between expansion and contraction. New orders and production indexes were both above 60. It's rare that these sub-indexes hits those levels, showing the unprecedented strength of demand that the industrial economy is currently experiencing. Prices are still an issue, however; the price PMI was over 90. Employment, however, is contracting -- which seems an atypical number considering the strength of the other data. And there is continued pressure on supply chains; supplier deliveries were over 70.
Each report also contains anecdotal comments, which are selected because they are representative of other comments. Here are some key points
I've noted in several recent pieces that raw material prices are coming down. Both the (DBB) and (DBA) have declined as of late. And lumber prices -- which were wreaking havoc in the housing market -- have dropped 50% in the last few months. Unfortunately, these declines will take awhile to work through the supply chain.
The Markit Economics PMI index confirms the strength in the manufacturing sector, with supply chain and price issues constraining the expansion:
“June saw surging demand drive another sharp rise in manufacturing output, with both new orders and production growing at some of the fastest rates recorded since the survey began in 2007.
“The strength of the upturn continued to be impeded by capacity constraints and shortages of both materials and labor, however, meaning concerns over prices have continued to build.
“Supplier delivery times lengthened to the greatest extent yet recorded as suppliers struggled to keep pace with demand and transport delays hindered the availability of inputs. Factories were increasingly prepared, or forced, to pay more to secure sufficient supplies of key raw materials, resulting in the largest jump in costs yet recorded.
The following chart from the Markit report shows the strength of the current expansion historically:
The current reading is near a 13-year high.
This has translated to rising industrial production:
Total industrial production increased 0.8 percent in May. Manufacturing production advanced 0.9 percent, reflecting, in part, a large gain in motor vehicle assemblies; factory output excluding motor vehicles and parts increased 0.5 percent. The indexes for mining and utilities rose 1.2 percent and 0.2 percent, respectively.
In May, at 99.9 percent of its 2017 average, total industrial production was 16.3 percent higher than it was a year earlier but 1.4 percent lower than its pre-pandemic (February 2020) level. Capacity utilization for the industrial sector rose 0.6 percentage point in May to 75.2 percent, a rate that is 4.4 percentage points below its long-run (1972–2020) average.
Here is the table from the report:
The Federal Reserve divides the data into two groups: major market groups and major industry groups. Both have been expanding at strong rates since January. The decline in February was attributed to the Texas blackouts.
The above chart from the St. Louis Federal Reserve's FRED Economic Data System shows 10 years of history. While industrial production declined sharply last Spring, it has regained a large percentage of its losses.
Sector conclusion: the industrial sector is firing on all cylinders. Demand is outstripping supply. Companies are running at full capacity and their respective material demand is outstripping their suppliers. There is no reason to think this trend will stop anytime soon.
Whenever I look at a sector-specific ETF, I first compare its performance to 10 other sectors that collectively represent the US economy. Those sectors are the XLB, XLC, XLE, XLF, XLK, XLP, XLU, XLV, XLY, and VNQ.
Data from Finviz.com
The XLI (NYSEARCA:XLI) was a key part of the reflation trade, which bid-up economically sensitive sectors in response to the economy reopening. That explains the XLI's strong performance in the 1-year time frame. However, it has since dropped-off as other sectors have reasserted leadership.
For our purposes, there are three relevant charts:
The weekly chart shows that the ETF is still in the uptrend that started last Spring. However, prices have recently sold-off a bit and are now right at the trend line.
XLI with only the following EMAs: 10-day (in blue), 20-day (in red), 50-day (in green), 200-day (in magenta).
The analytical benefit of looking exclusively at the EMAs is they strip out the daily noise of price bars. We can also think about the EMAs as price movement averages of short (10-day and 20-day), intermediate (50-day), and long-term (200-day) duration.
The long-term trend (represented by the 200-day EMA in magenta), is positive. However the intermediate trend (represented by the 50-day EMA), while still generally positive, is just barely so. That's because the short-term trends (represented by the 10 and 20-day EMAs in blue and green, respectively) have trended lower.
On the 3-month chart, the XLI has broken a shorter-term trend and is now consolidating lower.
While the macro backdrop is still very positive, the ETF is consolidating gains that built during the last year. If you've got the ETF, keep it barring a brutal sell-off. But don't take a new position until the consolidation plays out.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.