Basic Materials And Industrials Sector Overview For September 2020

Investment thesis: the fundamentals for basic materials and industrials are still good. Raw material prices are rising, new orders for durable goods are increasing, and industrial production is rebounding. But while the XLB and XLI have been solid performers during the last few months, both are now in modest corrections. Wait for these to play out before taking a new or adding to an old position.

Let’s start with the cost of raw materials

Overall, price pressures are modest. Copper (left) declined from the end of 2018 until the lockdowns; it has since rebounded but is relatively tame. Iron ore (right) has been increasing since the very end of 2015 but is still off highs are 2010-2012.

Here is the 1-year chart of the DBB (the industrial metals ETF):

Prices rallied from lockdown lows. But they’re now at levels from 1 year ago while also printing a potential double top which is confirmed by declining momentum. Volume was higher on the first top.

Durable goods orders continue to increase.

New orders for manufactured durable goods in August increased $1.0 billion or 0.4 percent to $232.8 billion, the U.S. Census Bureau announced today. This increase, up four consecutive months, followed an 11.7 percent July increase. Excluding transportation, new orders increased 0.4 percent. Excluding defense, new orders increased 0.7 percent. Machinery, also up four consecutive months, led the increase, $0.5 billion or 1.5 percent to $31.2 billion

Here are the relevant data charts:

Total orders (left) rebounded strongly from the Spring drop. The current level is still below pre-pandemic levels. The Y/Y percentage change (left) is still negative.New orders for non-defense capital goods (left) have rebounded; they are now near a 2-year high. The Y/Y percentage change (right) is positive again.

The Federal Reserve’s Industrial Production report has posted several months of gains, although the latest report showed weaker increases:

The column second from the right shows the latest month’s data. The top line growth figure was .4%, which is the lowest increase since May. Other sub-categories were also low. Here’s a chart of the data:Industrial production (left) continues to rebound but is still below pre-lockdown levels. Capacity utilization is also low compared to levels from the Spring.

The latest ISM Manufacturing Data indicates the sector is in a solid rebound:

The PMI index rose 1.8 points and is now at a solid 56. New orders and production are both over 60, indicating strong growth. The sector is still shedding jobs, although it is doing so at a slower rate.

Both the XLB and XLI have been strong performers during the last few months. But it’s likely both are now in modest corrections. Let’s start with the XLB:

Prices had been in a solid uptrend that started in early May. There are two trend lines supporting this move higher. The longest one connects lows from early May and early September; the shorter connects lows from early June to early September. Prices broke this trend earlier this week, which was accompanied by a drop in momentum.The weekly charts shows a clear trend break. Prices are likely headed to the lower 60s.

The XLI is also correcting:

The XLI was in a solid uptrend that started in early July. Prices hit resistance in the lower 70s early this month — an important level established in late February. Prices broke trend and are now resting on the 50-day EMA. The next logical area of support is the 200-day EMA.The weekly chart has likely formed a rounding, a standard reversal pattern.

Wait until these corrections play out before moving into either ETF.

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.

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