One of the US Equity sectors I pay the closest attention to for a read on the broader market is Industrials ($XLI). This is also true for Financials ($XLF) and Technology ($XLK) as these three Sectors are home to many of the most ubiquitous and vital companies in the US economy. They are also some of the largest groups on a market cap basis, along with Healthcare ($XLV), which means their performance is paramount to the health of the overall market.
The bottom line is if the largest and most important sectors of the stock market are all performing well and making new highs, then the overall market is likely to be following suit. This is exactly what we are currently seeing as XLF, XLI, and XLK are all exhibiting positive momentum and outperforming according to the weekly Relative Rotation Graph (RRG), shown below.
These three sectors are in a leadership position as they are currently in the top right, or “Leading” quadrant of the RRG. Additionally, their bullish relative strength is evidenced by the trajectory of the RRG lines as they are sloped up and to the right, showing that their momentum is improving vs. the S&P 500.
Despite Technology and Financials having much higher weightings in the S&P 500 than the 10% allocation for Industrials, Industrials have the strongest historical correlation to the major indexes. For this reason, we care more about Industrials than any other sector when assessing the outlook for Equities. Here is a long-term look at the S&P 500 Index ETF, $SPY, and the Industrial Large Cap Sector SPDR, $XLI.
As you can see, the two charts look nearly identical over the long run. Their tight relationship is further illustrated by the strong quarterly correlation, which is pictured in the lower pane, currently at a very high reading of 0.98.
While the S&P 500 has been stair-stepping to incremental new highs over the past two years, Industrials just reclaimed their all-time highs from January of 2018 this past week. Let’s take a look at the absolute price chart of Large Cap Industrial ETF, $XLI, and see what it could be signaling about the broader market.
Prices are currently consolidating in a tight pennant formation just above their prior all-time highs in the low 80’s. After several tests of this level over the past two years, buyers were finally able to absorb all of the overhead supply, and as long as we remain above 80-81, the trend is higher in XLI. Considering prices went nowhere for 22 months, this breakout to new highs should have some legs.
Industrials finally resolving to fresh record highs and joining many other key areas of the market only adds to our bullish thesis as breadth and participation continues to broaden in the US and Internationally. In light of the strong relationship between the S&P 500 and XLI we discussed above, this strength from Industrials serves as robust confirmation of the new highs recently achieved by the major US Equity Indices.
While Dow Theorists will point to the lack of new highs from Transports as a potential caution sign, I’d argue the confirmation we just got from Industrials is far more important. The market certainly seems to be firing on all cylinders of late, and this is yet another feather in the hat for bulls. I hope you enjoyed this post! As always, reach out to me at Strazza@thechartreport.com with any questions or comments.