The first real test for any asset class coming out of a deeply oversold environment is how it responds to its first overbought condition. Persistent upward momentum in the face of this headwind is usually quite bullish and, in many instances, signals the start of a pending trend change. It’s when these rallies are rejected at resistance that the downtrend in place is confirmed. I mention this because Industrials are starting to feel the effects of their overbought condition as multiple resistance points lay overhead. People will point to CAT’s disappointing quarter as the impetus for today’s action, but it’s worth noting that a few charts in today’s note were suspect of this recent oversold rally. With the internals entering overbought territory (% over 50-day), equal-weight indices have been lackluster off the lows, the yield curve remains suspect and excluding the rails, transports remain dubious.
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Trade wars, what trade wars? Don’t tell that to a few of the higher beta market plays, as the Russell 2000 closed up a touch near all-time highs while NFLX and AMZN rallied another 3.7% and 0.6% respectively. While many have traded under the belief that these components of the market are insulated from these headwinds (let’s see how long this can last), the same cannot be said of the industrials sector. Sitting roughly 10% below its January peak and unable to make any meaningful upward progress, bellwethers such as BA, CAT and DE look increasingly distributive. Machinery, Conglomerates and to a lesser extent Aerospace and Defense are the main culprits, and it doesn’t take a technician to see that there is something more than merely tweets about trade percolating beneath the surface. Machinery is the most worrisome and it isn’t an isolated occurrence, but a broad based and growing concern. There are 14 machinery names in the S&P 500 and 11 of them trouble me from a technical perspective. Now, there are clearly pockets of cyclical leadership within the sector (e.g. rails, trucking), but the relative strength of professional and commercial services speaks to the rapidly growing risk aversion that is infecting the sector. Back in early April I discussed how the charts favored transports over machinery (Industrials: Long Transports/Short Machinery?), and whether it’s the fear surrounding trade wars, emerging markets or a cyclical slowdown in global activity, as we head into what is lining up to be an interesting summer - the charts continue to provide a similar message.
Wolfe’s 11th Annual Global Transportation Conference kicks off tomorrow (05/22/18) (Wolfe Transport Conference Agenda), and I thought that it would be helpful to provide a little technical color on each of the presenting companies. Overall trends for the Transportation index remain constructive, but when I dig beneath the headline index, it becomes abundantly clear that the strength is not ubiquitous. The rails remain clear standouts, accelerating to all-time highs – strength that is currently being confirmed by fresh relative highs as well. Trucking along with Air Freight & Logistics are exhibiting solid momentum off of support; unfortunately, the same cannot be said for the airlines as they continue to languish, unable to generate any semblance of upward momentum. With multiple names hugging their respective support levels, will management’s commentary in the days ahead provide a much needed spark?
With the markets continuing to act lethargic, trying to identify stocks exhibiting strong momentum within bigger base formations has become more challenging to say the least. This is why I want to draw your attention to Scott Group’s note from last night on Wabtec (WAB - More Good than Bad from a GE Deal), as well as his upgrade back in February (WAB: Upgrading to Outperform on Signs of Inflection).
During times of market turmoil, a select few are immune to some degree of trend damage on an absolute basis. That’s why that in times like this, an industry’s or stock’s relative trend, becomes a truly differentiating factor, helping to distinguish the haves from the have nots. I mention this because transports have been pretty resilient given the market’s struggles over the past couple of months. The rails and truckers are at the core of this strength; unfortunately, the same cannot be said of the airlines, as momentum has been waning over the last several months. While I am hesitant to step into a majority of the names until bullish momentum presents itself, SKYW and ALGT stand out on the long side.
Hovering at crucial support last month, Airlines delivered exactly what the bulls wanted to see out of the important oversold environment. Now overbought at resistance, how they respond to this overhead supply will be an important tell for the start of ‘18. Plenty of work lies ahead, but their recent response has gone a long way in helping to solidify what had been a questionable trend.
Should we worry about the developing divergence between transports and the broader market? We have received a fair number of questions with regards to this concern, and I want to caution against reading too much into this recent period of underperformance. The main culprit behind the lagging performance has been the airlines, while Air Freight & Logistics, Rails and Trucking remain firmly within their respective uptrends. Airlines responded favorably to their deeply oversold conditions in late August, only to see upward momentum quickly dissipate at resistance. On the verge of oversold once again, failure of sustainable upward momentum to present itself would clearly be an unwelcomed development, providing additional ammo for the bears. Today’s report takes a look at the individual names within the industry, and while some look extremely worrisome, one particular name could be confused for a leadership tech company.
Entering the thick of earnings season deeply overbought, it’s fair to say the recent lull in volatility is unlikely to last for long at the stock level. The good news is that industrials, along with the broader equity market, possess healthy underlying trends, signs of internal momentum, confirming credit and positive seasonal tailwinds. This backdrop should continue to support leadership trends and we would use volatility around earnings as an opportunity to build positions heading into year-end.
After rallying to all-time highs in mid-July, with the exception of Aerospace & Defense industrials have seen a loss of momentum across the board. This growing risk aversion is further reinforced by the bond market’s increasingly skeptical view. The most notable of which has been the violent reversal in airlines, and the group’s inability so far to generate any meaningful momentum out of the current oversold condition. I’m willing to ride out the oversold condition, but it’s time for upward momentum to present itself.
Of all the charts that I look at weekly, the long-term relative base that the industrials sector has carved out continues to be one of the more interesting setups in the market today. Despite a great amount of volatility over the past decade, industrials have made little headway versus the broader market. However, if our view of the chart below is correct, the sector is setting up for a sustained period of outperformance. Thanks to challenging seasonality, our outlook is not without risk in the near-term, but we remain extremely intrigued with the way the sector sets up from a long-term technical perspective.
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