June Sector Update – Industrials

While prepping today’s Industrial sector note, the biggest question was not which charts to include, but rather, which charts can we leave out?

All year we’ve been talking about the underlying strength within the sector, but that underlying strength hasn’t really mattered. The only thing that’s mattered is large cap growth – investing anywhere else has led to rather sub-par gains.

Still, we’ve kept our overweight rating on Industrials because we’ve viewed them as the best positioned of all the value-tilted sectors, and we’ve believed that a rotation back from growth into these other areas of the market was likely.

Our views were reinforced each time we compared the equally weighted industrials sector to the equally weighted S&P 500 index. Here, the sector has been ripping to new highs after a successful backtest of the initial February breakout level. There’s a ton of underlying relative strength here.

It’s just that the strength has been masked by the dominance of mega caps within growth sectors. The cap weighted ratio below shows how Industrials led the market out of the October lows, then broke out to multi-year highs in the fourth quarter of 2022. But as growth surged to start the year, Industrials were forgotten and the ratio slid back to that initial October breakout level. That level had quite a bit of importance last year, and it makes a lot of sense to see Industrials trying to stage a relative rally from here.

We’re finally seeing some real strength on an absolute basis, too. Industrials just broke out to new 52-week highs this week:

Again, we can see how much strength Industrials were showing, even while they were absent for most of the 2023 rally. Momentum – in the lower pane – stayed in a bullish range throughout the consolidation. It never fell into oversold levels. You can’t say that about Energy or Financials, other value-oriented sectors. We’re finally starting to see the fruits of that underlying strength.

So let’s take a look at some of the stocks leading the move. Again, we can’t touch on every stock that’s rallying, or else you guys would be here all day. There’s so much to like out there.

First, let’s check in on the stocks we’ve highlighted over the past few months.

Transdigm no longer offers a great risk-reward opportunity, so there’s no reason to get involved now if you haven’t been. But for those that were able to initiate positions on the initial breakout or on the pullback toward our 670 risk level earlier this year, we still believe this one can get up to 930, which is the 161.8% retracement from the 2020 decline.

Howmet Aerospace continues to work as well, though it, too, has quite a bit of room to our risk level of 40. Still, we’re talking about more than 10 years of consolidation. The bigger the base the higher in space (pun intended). Our target for this one is 70, which is where things really started to go south back in 2008.

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General Electric is another that’s been on our list for several months, and it’s done nothing but trek higher. The risk-reward isn’t what it used to be, as we’re well above support at $90, but we still think it can go all the way back to that initial breakdown level of $145.

Snap-On is coming out of a multi-year base as well, the top end of which has been the 161.8% retracement from the 2018-2020 decline. We’ve wanted to own this one above 260 with a target of 340, which is the next key retracement level.

We haven’t missed anything in Rollins yet, and we still think it’s poised for a breakout from this 3-year consolidation range. We don’t want to waste our time with this one unless we see those fresh highs – there’s too much opportunity cost in owning something that could easily take another few months or years to absorb all this overhead supply – but on a move above 43 we don’t want to let this one get away. Our target is 55, which is the next key Fibonacci retracement level from the 2019-2020 consolidation.

Check out these new highs in Grainger. After a surge at the end of January that pushed the stock above the 423.6% retracement from the 2013-2018 consolidation, this one had been consolidating above that level. This month, it’s found renewed vigor.

One thing we love to see in a stock is strength on both an absolute and a relative basis. That’s exactly what we’ve got in GWW. It spent 10 years(!) trying to get back to the relative highs it set in 2012. It failed at those former highs last October, then pushed above them in January and successfully backtested them in April and May. With this kind of favorable backdrop, we want to be owning Grainger with a target of 970. We’d change our minds if it fell back below 660.

AMETEK just moved past its 2022 highs after battling with them for the last 6 months. We think it can go to 172, which is the 161.8% retracement from last year’s bear market.

We’ve got an identical setup in Ingersoll-Rand. If the names and prices were stripped off these two charts, you wouldn’t be able to tell the difference. We want to be buying IR above 62 with a target up near 76.

A.O. Smith continues to consolidate above the neckline from last year’s inverse head-and-shoulders reversal pattern. The risk couldn’t be more well-defined for us on this one: we want to be buying AOS on a move above 70 with a target back at those all-time highs near 85.

Axon Enterprises has pulled back nicely towards support after a big breakout earlier this year. We like how this one’s consolidated within the backdrop of a longer-term uptrend. It needs to hold 190, which is a key retracement from the 2018 selloff, but longer-term we’re eyeing 275, which is the midpoint of two Fib retracement levels from the last two major consolidations. Those ‘clusters’ of retracement levels tend to work really well.

Caterpillar is back on our radar now that it’s digested that failed breakout from earlier this year. From failed moves come fast moves in the opposite direction, and sometimes those result in trend reversals. But just as often, it just takes a little more time to digest all that overhead supply. That’s what’s happening here with CAT. We want to make sure it holds above 240, but we’re targeting a move to 335 after 2 years of going nowhere.

One area that’s been a big drag on the sector has been the transports, but they’re trying to turn things around. Here’s the SPDR Transportation ETF (XTN) testing former resistance. A breakout above that can’t be anything but bullish for Industrials.

Airlines are leading that move in transports. There are 3 necessary steps in reversing a downtrend: set higher lows, break the downtrend line, then set higher highs. What do you guys think? Looks like a reversal to us.

We don’t love the setup in any individual airline right now – most are in the middle of ranges without clearly defined levels – but we do love that even some of the weakest stocks in the sector are finding ways to move higher. That certainly isn’t bearish.

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