Is the heavily beaten down Industrial sector out of the woods now?

The time has come again for us at DowExperts to share with you our most recent ETF correlation analysis and overall market observation, in order to help you to prepare for what’s coming in the month of June. The market movements in the past 10 weeks altogether have been nothing short of spectacular all across the board, as we saw substantial continued gains on all major US indices, marking the strongest 2-month period for the US stock market since 1987. The fundamental factors that played a crucial role in the last two month’s price action were associated with new unprecedented monetary and fiscal stimulus measures by the Federal Reserve and the US government; with some positive developments on the medical front with new improved testing solutions and potential anti-viral treatments for COVID-19 and last but definitely not least with the official reopening of the US economy, as now all 50 states are out of the COVID-19 related lockdown.

Today’s analysis will focus on the strong positive 10-year correlation between the SPDR S&P 500 ETF Trust (SPY) and the Industrial Select Sector SPDR Fund (XLI), which currently stands at 93%. As you know, the Dow Experts have developed a modern-market approach, based on the Dow Theory and created by Charles Dow more than 100 years ago. Yet, while the basic Dow Theory was based purely on the correlation between the Dow Jones Industrial Average and the Dow Jones Transportation Average, our modern-market approach is based on more than 30 correlations, including all the other key sectors on the market, such as Technology, Services, Consumer discretionary and non-discretionary, Financials, Energy and others. Furthermore, our modern approach focuses on the usage of both fundamental and technical analysis because we believe that the combination of these two ways of analyzing the market into one rational analysis approach is vital for one’s success and profitability in the market nowadays. The correlation-confirmation model we have developed allows us to identify market reversals, as well as trend continuation patterns. Following the Dow Theory 2.0 we are able to issue specific high-probability trading setups, which in turn could help our followers to benefit from both bullish and bearish markets.

Throughout the last few months our analyses have helped hundreds of our followers to be better equipped for tackling the unprecedented market environment and volatility that we have experienced recently. Our innovative approach delivers highly qualitative market analyses by looking across 30+ correlations, multiple different sectors, industries and asset classes which enables us to have a multi-layered confirmation on the next direction for the market. This is the reason why we were able to spot the broad-based market weakness at the end of February and recommended for our followers to be cautiously bearish and further gave them strategies to protect their capital from the upcoming downturn. Subsequently, in late March we were also able to identify that the market had already extended far too much to the downside and that a strong rebound was to be expected in April. In both of these scenarios, the new and innovative Dow Theory 2.0 not only protected our followers, but also allowed them to generate outstanding returns as well. Every single one of our Stock-picks for April has reached its respective take profit levels that we laid out in our analyses, thus marking an outstanding appreciation of 25% on average in the last 4-6 weeks! Our stock-picks for May have also reached their initial take profit levels, thus generating 15% return on average in the last 2-4 weeks. If you take a second and think about the fact that having a $20-40 subscription with the DowExperts could have generated you a 25% return on your investment (ROI) in less than 4 weeks, you would understand that this is an unprecedented opportunity for you as an investor to benefit from our professional and highly complex market analyses at these substantially discounted starting prices!

Now let’s look ahead and see what the Dow Theory 2.0 has in store for us for the month of June and how we could further optimize our investment portfolios moving forward in order to reduce our risk-exposure and maximize our profitability in these uncertain times. The proper re-balancing and sector rotation is exceptionally important in such volatile market conditions, as you need to always make sure that your capital is properly allocated, if you want to be well diversified.

Ray Dalio, the CEO and founder of Bridgewater Associates, or in other words the largest hedge fund in the world says that diversification as a concept is probably one of the most valuable and important things that you need to pay attention to as an investor. The main reason for that is that if you really know how to minimize your overall risk exposure and allocate your capital with the proper tools and percentages in the right markets, then you could put yourself in a situation of almost guaranteeing yourself to generate profits.

The two ETFs that we will be analyzing closely today are the SPY – SPDR S&P 500 ETF Trust and the XLI- Industrial Select Sector SPDR Fund, as this would give us a great indication as to what is the current underlying stability and strength in the market. It is important to note that some of the largest companies in the Industrial sector have been among the biggest 2-month winners in terms of individual stock gains. However, also lets not forget that these were also some of the companies that suffered the most initially from the pandemic. Thus, we would like to look closer at the broader market as well as this particular sector and use our confirmation correlation approach in order to build our capital allocation program for June. Furthermore, we believe that by investigating more closely the broader market and the Industrial sector specifically we would be able to clarify if the remarkable gains that we have seen in the last few months are sustainable or if this was just another overenthusiastic and emotional move that is about to collapse very soon.

We will first analyze the broader economic and fundamental developments in the last month in order to evaluate what is the most likely scenario for the market for the month of June. The market environment has continued to change on a daily basis in the last few weeks and there have been hundreds of news and updates that we need to pay attention to in terms of monetary and fiscal stimulus measures, medical innovations and improvements, and general economic data readings. Looking into all of these details will have an important role in determining our overall bias for the weeks ahead. Later, we will investigate the SPY and XLI sector ETFs independently and we will see how they stack up against one another in terms of correlations, confirmations and signals. Last but not least we will recommend 2 stocks in each of the two sectors for our followers to consider taking advantage of in the coming weeks!

Economic Outlook

We at DowExperts believed that after seeing the crazy and unparalleled roller-coaster ride that the markets went through in the March-April period, that the month of May would have brought a sideways price action, which would have ultimately allowed investors to reposition themselves in an efficient manner for the long-term. However, investors have continued to pile up on the long equity market exposure seemingly not being worried about the fact that on average stocks are much more expensive on an earnings basis today, than they were when the market was sitting at the all-time highs back at the end of February.

The Shiller 10-year P/E ratio of the S&P 500 back then was sitting at around 25, whereas today it is at 30. From a valuation perspective this puts the current stock-market valuation in the Top 20% of the most expensive markets since 1871. Furthermore, it is important to note that the Shiller 10-year P/E ratio has been a very accurate financial metric for predicting the future price movements of the S&P 500 as it shares a 99.7% positive correlation with the composite.

It is very important for intelligent investors to always keep track of how expensive the market actually is in relation to historical averages and recognize what are the drivers for the market to be cheaper or more expensive now than before. However, this is easier said than done and usually only professionals are able to look at the market and apply an objective evaluation of the situation, while most of the retail traders and beginner investors prefer to focus on things like hype, emotion, momentum, greed, fear rather than focusing on actual economic and financial data.

So, isn’t it crazy to think that during the full-blown global economic shutdown created by COVID-19 while tens of millions of people were loosing their jobs and the unemployment rate in the US climbed to levels not seen since the Great Depression (1929), the US equity markets have not only rallied in a completely astonishing way with more than 45% but are also now much more expensive than they were back in January. Just to remind everyone that the US economy was in a tremendous shape before COVID-19 as we were seeing consistent 200K+ jobs created every single month, high productivity levels, GDP growth and the lowest unemployment levels in history. You don’t have to be a financial guru or an economic expert to identify that this doesn’t sound right and the logical question then would be, so where does this positivity in the stock market come from. The answer to this question is a combination between an aggressive monetary and fiscal stimulus by the Federal Reserve and the government and people’s greed and desire to get rich quick.

The Fed

In times of an unprecedented broad economic shutdown caused by the COVID-19 pandemic, central banks around the world realized that the risks of a global economic depression are not only real but that they elevated by the day back in the March-April period, as every day the world stayed shut cost billions of dollars of actual realized losses for virtually every sector our there. Thus, the Federal Reserve, which is the largest and most influential central bank in the world decided to adopt an actively supportive “by all means necessary” approach basically announcing their readiness to provide an unlimited financial stimulus for the US economy in order to avoid another depression.

“We are deploying these lending powers to an unprecedented extent [and] … will continue to use these powers forcefully, proactively, and aggressively until we are confident that we are solidly on the road to recovery,” says Jerome H. Powell, Chair of the Federal Reserve Board of Governors.

They cut the benchmark interest rates to virtually zero and rolled out a series of emergency and unorthodox lending facilities designed to backstop markets and keep credit flowing to businesses. The Fed’s balance sheet has already reached $7.2 trillion, which is the largest it has ever been. One of their latest measures was to include $2.3 trillion in lending to support households, employers, financial markets, and state and local governments. Additionally, the Fed resumed its Quantitative Easing program aimed at purchasing massive amounts of securities a key tool employed during the Great Recession, when the Fed bought trillions of long-term securities. As a result of the COVID-19 outbreak both the treasury and mortgage-backed securities markets have become completely dysfunctional, and the Fed’s actions aimed to restore smooth both investors confidence and market functioning so that credit can continue to flow. The initial commitment by the Federal Reserve was to at least $500 billion in Treasury securities and $200 billion in government-guaranteed mortgage-backed securities over “the coming months.” However, the followed historic market declines and broad-based panic caused the Fed to modify its monetary policy, thus making the purchases open-ended. It also expanded purchases to include commercial mortgage-backed securities, which was another unexpected and unprecedented move, as it basically means that there is no limit as to how much the Fed is willing to inject into the economy.

The Federal Reserve also slashed the reserve requirement for banks and begun buying up commercial paper (a form of short-term corporate debt). It also started buying municipal bonds for the first time and took its first steps into certain types of riskier corporate bonds, and it’s promised to buy an unlimited amount of government debt for the duration of the crisis. It will also backstop loans from bank lenders participating in the Paycheck Protection Program.

Fiscal help – CARES Act, Heroes Act

Regardless of the powerful monetary stimulus provided by the Fed, the economy needed a government intervention on the fiscal side as well in order to stay above water in these difficult times and the US government knew that. Thus, it delivered massive liquidity packages throughout the last few months including the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and a $484 billion Coronavirus relief package aimed at helping Small Businesses survive. The latest major government fiscal initiative is called the $3 trillion Heroes Act, which was introduced by House Democrats and passed the house in the beginning of this month. The major focus of the bill is the $875 billion in additional funding for state and local governments and $20 billion each for tribal governments and U.S. territories. The new legislation also includes another $75 billion for testing, new provisions for hazard pay for essential workers, $75 billion in mortgage relief, $100 billion for rental assistance, plus another $25 billion for the Postal Service and provisions for a second round of $1,200 stimulus checks. In addition to all of that there’s also $3.6 billion for elections, $10 billion for the Supplemental Nutrition Assistance Program and $10 billion for small businesses. If it passes the Senate in its current form, the bill’s astronomical price tag would make it the largest piece of stimulus legislation in American history.

The result – False optimism, greed and the fear of missing out (FOMO) led to a highly overbought and overvalued market

The combined and relentless approach on the monetary and fiscal side has substantially increased investors confidence that not only the Fed but also the US government are staying on top of this current crisis and are both ready to do whatever it takes to help businesses and individuals to survive this economic destabilization. This has been the major reason for the continued appreciation of the stock market in the US in the last few months. However, we at DowExperts believe that while it is tremendously important for the government and the Fed to continue to support the economy in this active manner, at the same time we have to face the fact they neither of them is able to create real economic growth and activity by simply pouring endless amounts of capital into the economy. With over 40 million people being unemployed in the US, it will take a very long time for the economy to get back to its pre-COVID levels of activity and productivity. In reality this means that all of the companies out there will see downward revisions of their revenue and earnings expectations for the next 2 quarters, which will ultimately slower their growth, lower their intrinsic value and will inevitably lead to some price declines. Let’s not forget that more than 80% of the publicly traded companies in the US officially withdrew their fiscal 2020 guidance when they delivered their Q1 earnings reports in the last couple months. This is one of the many warning signs that we at DowExperts identify and recognize as an indication that the road ahead could be much tougher than everyone expects.

When you see that the main drivers of this historic rally off the lows are strong liquidity injections by the government and the Fed; speculation about a quick economic recovery, without any real proof that this is even a realistic scenario; greed caused primarily from the fear of missing out; and the general misconception that the fact that the economy is “reopening” means that the economy is “recovering”, well you must ask yourself whether or not you believe that this is a sustainable and healthy environment for the market to continue to rally in the future as well.

We at DowExperts believe that the economy is not going to fully recover until we start seeing actual consumer spending, consistent job creation, lower unemployment rate, productivity and manufacturing growth and many other economic indicators that are currently painting a very dark picture as a whole. Thus, we are issuing once again our cautious and rather bearish sentiment for the coming month, as we believe that even if the market doesn’t revisit its March 23rd lows, it will be definitely trading lower in June than where it was trading at the end of May.

SPY – XLI: S&P 500 vs. Industrials

Sectoral Fundamental Analysis

SPY

As you know, the SPY is an exchange-traded fund created to follow the movement of the S&P 500, which in turn is a stock market index that measures the stock performance of the 500 largest companies listed on stock exchanges in the United States. The SPDR S&P 500 Index Trust (SPY), launched in 1993, is the oldest, largest, and most liquid ETF, with over to $286 billion in assets and an average daily trading volume of $26 billion. The fund tracks the most popular US Index, the S&P 500 and invests in the large and mid-cap stocks selected by the S&P Committee. In other words, it is an extremely liquid ETF that invests in the biggest companies within the S&P 500, giving an opportunity for investors to get an exposure to the most well-known companies out there without having to pick individual stocks by themselves – a very suitable option especially for less experienced investors.

This ETF is always a go-to place for understanding the dynamics of the ETF market as a whole. There are 11 individual sector ETFs that are derived from the SPY, in order to differentiate and place the 500 different companies into their respective sectors and industries. This as a result has created a closed circle of strong correlations, which we use daily as a market indicator with potential 11 layers of confirmation. Furthermore, the strong correlations that we have identified within the different sector ETFs out there have been placed into a large correlation matrix, where we could easily identify and estimate what’s the likelihood of a certain signal to be accurate. This helps us to navigate our investment decisions and rationale in a more productive and efficient manner.

The SPY is heavily dominated by the Technological sector as it currently represents 31.37% from the fund, with the rest of the Top 5 spread across Healthcare (15.25%), Consumer Cyclicals (13.14%), Financials (13.03%) and Industrials (8.42%). However, surprisingly enough even though that the XLK has the largest representation in the SPY, the most strongly correlated sector to the SPDR S&P 500 Index Trust is the Consumer Cyclical (XLY) sector with a 94% 10-year positive correlation followed by the Industrial sector (XLI) with a 93% correlation.

XLI

The XLI tracks a market-cap-weighted index of industrial-sector stocks drawn from the S&P 500.

It provides investors with an exposure to the industrial sector in the US that is cheap to hold and very easy to trade. The fund invests in companies within the S&P 500 by limiting its small and mid-cap exposure in order to concentrate mainly on the biggest industrial players on the market. The XLI provides a great exposure to the industrial sector in the US and it is suitable for both traders and long-term investors thanks to its impressive assets, high trading volume and a low expense ratio. We have been analyzing the performance of the XLI for a long time now. We must say that the ETF has been a great representation of the overall performance of the industrial sector in the US. Due to the huge growth in the US economy over the past 11 years, the XLI had gone up from $15 to $85 (466%). Therefore, the XLI has been extremely profitable for those who like investing in ETFs and getting a direct exposure to one of the biggest sectors within the economy. Some of the biggest gainers in the last 4 weeks have been indeed Industrial giants like Boeing (BA), General Electric (GE), Honeywell (HON) appreciating with 161%, 54%, 58% respectively. Was that just a simple rebound from extreme oversold conditions for these stocks or was that the beginning of the full recovery for these companies? Well, quite frankly we at Dow Experts believe that it is a bit of both. It is true that these stocks were obliterated during the huge market declines in March on the back of high levels of uncertainty in regards to the reopening of the global economy and the restarting of their business operations, thus they were definitely due for a meaningful pullback from these depths on the charts that they were sitting in just a month ago. At the same time, we have seen the US and Global economies reopening with people going out of their homes and slowly getting back to a more active and busy lifestyle, which is a positive sign for the economy and a positive sign for some of these industrial stocks, as they rely on the economy functioning properly.

Technical Analysis

SPY

By looking at the daily chart of SPY we can clearly see that the price has moved strongly to the upside in the last 2 months, following the broad market historic bull-run off the March lows. The ETF has enjoyed a remarkable run from the $218 mark to the $324 level that it reached in the beginning of June, thus marking a 48.6% gain in 8 weeks! It has been able to almost fully recover the losses caused by the pandemic shock in March and now is testing the strong horizontal resistance around $325. We saw a strong rejection on the first attempt of the SPY to overtake this crucial technical level as the price was sent down sharply with more than 8% in the period June 10-12th. The SPDR S&P 500 Index Trust (SPY) is now sitting at the $305 mark, which coincides perfectly with the diagonal upward sloping trend support and with the strong horizontal and psychological support around $300. The diagonal upward sloping trendline support has been acting as crucial floor for the price throughout this remarkable bull-run in the last 2 months and the ETF has managed to bounce off of it on once before. Furthermore, the price is also sitting at the 23.6% Fibonacci retracement level, where we believe that if a break occurs then we could easily see the price sliding towards the 50% and the 61.8% Fibonacci levels that are located at the $270 and $258 levels respectively. The RSI and Stochastic indicators have turned sharply lower and are headed into bearish territory, thus threatening their respective uptrend support lines. We at Dow Experts believe that the week of June 15th will prove to be critical for the next major move for the markets. If the major support levels mentioned above are broken then this would open the door for a much larger decline into the end of the month, which in turn would create a great long-term buying opportunity for all of our followers. However, if the market manages to bounce from the current initial support levels, then we would most likely see a re-test of the strong resistance levels that rejected the price last week. Once the re-test of $325 occurs it will be important to see whether there will be enough bullish momentum and positive price action to break higher, or the price will fail again, thus signaling a much broader underlying weakness. Our analysis shows that any rally towards the above-mentioned resistances will find substantial selling pressure as market participants continue to realize that the global and US economies are still in a very difficult position at the moment despite the fact that they have officially reopened. The weak underlying fundamentals will definitely put some downward pressure on the market and when you combine that with the major profit taking interest out there, then you have somewhat of the perfect storm coming for the market. After all, let’s not forget that the US indices have appreciated with more than 45% in the last 8 weeks and a lot of investors are sitting on some great profits, which they will not risk in this environment.

Dow Theory 2.0: Correlation Confirmation

As you know, we at Dow Experts have developed a correlation confirmation model that allows us to identify, analyze and confirm different market movements, which in turn helps to improve and maximize our followers’ investment profitability. So, before we take any action on the SPY we need to make sure our short-term bearish expectations are confirmed by the other ETF we are analyzing today – the XLI, and only if we get a confirmation from it then we would proceed with selling the XLI. The SPDR S&P 500 ETF Trust and the Industrial sector share a very strong 93% positive 10-year correlation, thus both the potential confirmation or rejection of the signal would be a reliable indication for us as to where the market is headed next.

XLI

When looking at the daily chart of the Industrial Select Sector SPDR Fund (XLI) we can clearly see that after the precipitous declines back in March when we saw the ETF losing 44.7% of its value, Industrials have made a spectacular comeback in the last couple of months. The sector has rallied with the remarkable 58.3% from its lows and some of the largest Industrial names out there like Boeing, Honeywell and General Electric have been among the biggest gainers in S&P 500 altogether throughout the last few weeks. The technical picture is currently very interesting as the XLI has made some key upward breaks in the last couple of weeks around the $65 and $70 levels, which is generally bullish. However, at the same time the ETF was rejected strongly by the $78-79 major horizontal resistance mark and dropped nearly 12% as a result of that. Thus, the price is currently sitting at an important inflection point at the $68-69 level and in order for the strong bull-trend off the lows to continue we need to see a clear break of the $79 resistance. At the same time if the price drops below the $65 support zone, then this would totally invalidate the uptrend and will then open the door for a revisit of the $61 and $58 Fibonacci retracement levels. The Industrials are considered to be cyclical stocks or in other words sensitive to the overall state of the economy,. They need productivity, job creation and unemployment rates to normalize and for the economy to stabilize in order for them to start bringing the revenues and earnings that they need. Thus, we at Dow Experts believe that the recent sharp bearish reversal for the ETF was more than just a profit taking correction but rather a more meaningful indication that the oversold bounce has reached its upward limits and now its time for the fundamentals to take the lead again. We could definitely be in a position to find great value in some of the large industrial names in the coming weeks but only after they correct lower first, as they are too expensive at the moment when compared to the current state of the economy.

As a result of our cross-sector correlation confirmation analysis we will issue a cautious short-term bearish stance on the SPY and XLI as we expect the two ETFs to experience weakness and respectively move lower in the coming weeks. However, we would like to emphasize on the fact that these short-term price declines should be treated as great long-term buying opportunities by our followers as they will allow us to buy some of the best-in-class companies and our favorite stocks at a tremendous discount. You should always salute and welcome the opportunity to buy more of the best stocks out there, when the market moves lower. These two ETFs have been some of the biggest winners for a long time now and the reason for that is associated with the fact that the companies comprising these ETFs are the companies that define and shape the world that we live in today. Thus, the SPY and XLI will continue to be some of Dow Experts’ favorite long-term ETF holdings out there.



We at Dow Experts enjoy analyzing the market and helping our followers maximize their profitability by following our trading and investing ideas, which are always supported by our rational investment approach.

In order to further provide our followers with a strategy on how to fully capitalize on the above-described patterns and correlations, we analyzed the performance of some of the biggest companies within the SPY and XLY that have a big impact on the overall performance of the two ETFs.

You can subscribe to our Full Package in order to receive all of our top stock and ETF picks and analyses for the month plus new Bonus reports every month!

Sincerely,

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