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.
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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.
I came into the year believing that the Industrials sector was ideally positioned to finally break out through heavy decade long relative resistance. While the post-election consolidation has gone on a little longer than most would have liked, and while we’re troubled by the bond market’s message, we still like the technical setup. Recent momentum has been encouraging, with relative trends reaccelerating and successfully working their way through intermediate-term resistance. Overbought in the short-term, we don’t feel the need to chase at current levels, but would rather use consolidations and seasonal headwinds to our advantage. Led by Machinery, leadership continues to maintain a cyclical bias, and we’ve included a few of our favorite long and short ideas in today’s report
While equity trends continue to be constructive, catching up on the charts over the past few days, one thing in particular really caught our eye since we last published a little over 5 weeks ago...the bond market. While yields are fighting the good fight at 2.15% support, the curve has collapsed, and is now the flattest it has been since October of last year. Growth as a style had clearly become extended versus value, and while a reversion in both is to be expected, we have a tough time believing that value can post meaningful absolute and relative performance without bonds cooperating.