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Introduction: the (NYSEARCA:XLB) is one of a series of ETFs issued by State Street Investors that track a broad economic sector, which here would be the basic materials/raw materials sector. This ETF is the largest, broad-based ETF in the basic materials sector.
This article will first look at the macroeconomic backdrop of the basic materials sector. A growing basic materials sector translates into rising profits for companies that produce products for this sector, which, in turn, increases company valuations, and, hence, share prices. The reverse is also true.
Investment thesis: add the XLB to your portfolio. The economic and technical pictures are strong.
The materials sector supplies the raw materials for manufacturing. Therefore, the health of the manufacturing sector is of paramount importance for the XLB.
The macroeconomic sector is positive, as seen in today's ISM Manufacturing report (author has written permission to use the current month's report).
“Manufacturing performed well for the 19th straight month, with demand and consumption registering month-over-month growth. Meeting demand will remain a challenge, due to hiring difficulties and a clear cycle of labor turnover at all tiers. For the second month in a row, Business Survey Committee panelists’ comments suggest month-over-month improvement on hiring, offset by backfilling required to address employee turnover. Supplier delivery rate improvement was indicated by the Supplier Deliveries Index softening in December. Transportation networks, a harbinger of future supplier delivery performance, are still performing erratically; however, there are signs of improvement,” says Fiore.
The following table is also from the report:
The data is organized so that a reading of 50 separates an expanding from a contracting economy. Readings near 60 are considered especially strong.
Yesterday, Markit Economics released its latest PMI report, which was also positive:
The seasonally adjusted IHS Markit US Manufacturing Purchasing Managers’ Index™ (PMI™) posted 57.7 in December, down from 58.3 in November but broadly in line with the earlier released 'flash' estimate of 57.8. The improvement in the health of the US manufacturing sector was the slowest in 2021 amid subdued output and new order growth. Ongoing efforts to build safety stocks and a severe deterioration in vendor performance, ordinarily signs of improving conditions, continued to lift the headline PMI, however.
Like the ISM data, Markit Economics' report is organized so that 50 separates expansion from contraction.
Other data from US economic sources also shows a growing manufacturing sector:
From the FRED system
Total durable goods orders (upper left) continue to move higher after dropping sharply during the lockdowns. The same is true of non-transportation durable goods orders (upper right) and non-defense capital goods (think manufacturing machinery).
From the FRED system
Industrial production (left) and capacity utilization (right) have returned to their pre-pandemic levels. Both are also obviously in a large upswing.
The economic backdrop for the XLB is positive. Several key manufacturing reports show that the US manufacturing sector is growing at a solid clip. Orders for a variety of durable goods (which use basic materials as inputs) are still rising, as are overall industrial production and capacity utilization.
Now that we've established that the macroeconomic backdrop is positive, let's determine if this is an appropriate time to take a position in the XLB based on the charts. Let's start with the long-term trends:
2-Year chart with weekly bars (left) and 1-year chart with daily bars (right) from Stockcharts.
The weekly chart (left) is bullish. The XLB rallied from its low just below 40 in March of 2020 to a high just shy of 90 in the late Spring of 2021. The daily chart (right) shows a mostly sideways consolidation occurring last year. Prices moved between 87.5 and ~75 for the last 3/4 of the year.
3-Month chart (left), 30-day chart (upper right), 2-week chart (lower right) from Stockcharts.
On the left chart, start with the EMAs. All are moving higher with the shorter above the longer. Most importantly, prices are using the shorter EMAs as technical support, which is also bullish. At the end of last year, prices hit a new high and then consolidated sideways. This consolidation can be seen on the 30-day chart (upper right) and, more clearly, on the 2-week chart (lower right). A period of consolidation after hitting a new high is a healthy development.
Finally, consider the RRG chart of the 11 major index-tracking sectors from Stockcharts.com:
The XLB has just moved into the leading quadrant of the chart.
Conclusion: this is a good time to add the XLB. The economic backdrop is positive as are the charts. And, the sector is poised to outperform the SPY during the next few months.
