XLI: Industrials ETF approaches February 2020 support (NYSEARCA: XLI)

The selected industrial sector SPDR ETF (NYSEARCA:XLI) is down 14%, including dividends, since the start of the year. It’s actually slightly better than the SPDR S&P 500 ETF (SPY).

YTD ETF Performance Heatmap: XLI Down, But SPY Outperforms in 2022

However, it is difficult to group together all the “industrial” actions. The sector is among the most diverse of the 11 groups in the S&P 500. Consider that in the space you will find machinery companies, aerospace and defense companies, integrated shipping stocks, recruitment agencies , resource-based farming and agricultural enterprises, and transportation. There’s a lot going on.

And the performance differences are evident in 2022. Industrials have hot industries like aerospace and defense as well as food/agribusiness. Weak industries are among the more cyclical areas such as large, blue-chip industrial conglomerates and many business services stocks that are technical in nature.

Companies in the industrial sector: future PER (left), YTD performance (right)

The composition of the sector is quite diverse. Raytheon (RTN) is the largest holding, but there are many companies with similar weights in XLI, according to SSGA.

XLI Holdings

Overall, XLI’s negative alpha this year is nothing new. The sector has been on a relative downtrend from its peak in early 2018. Perhaps a bottom was reached during the second quarter of 2020, but the current consolidation, as shown in the weekly relative chart below below, looks more like a continuation trend to me. I am inclined to be bearish relative to the broader market.

Relative chart XLI vs SPY since (5 years, weekly)

Digging into some sector metrics, you’ll find that XLI is 7.8% of SPY and has a tilt toward value, according to JP Morgan Asset Management. It is, however, an important part of the small cap Russell 2000 Index. It is just behind the energy sector (XLE) when it comes to growth expectations over the next 12 months. As a result, the forward P/E is 17.4x, but this is still slightly more expensive than the 20-year industry average of 16.2x. Total shareholder return (redemption yield plus dividend yield) is close to the S&P 500 norm at 3.8%.

S&P 500 Sector Returns, Valuation and Returns

Industrials’ forward price-to-earnings ratio has fallen sharply since peaking several months ago, bringing valuations back to their long-term average. The PEG ratio, however, seems quite cheap.

History of industrial sector valuations: favorable PEG ratio

Based on the valuation of the group, the EPS growth rate outlook for this year has been stable since the start of 2021, currently at an extraordinarily high level of +36.4%, according to data collected by Ed Yardeni. Forecasts for the rate of earnings growth for next year have fallen after rising at the end of 2021 and at the start of this year.

Historic annual EPS growth forecast for the industrial sector

The technical grip

XLI is eyeing key support at the pre-pandemic top and successful retest point in early 2021 at $85. It needs to hold that, but there is a gap in the low $80s that could also be marked before an upside reversal occurs. Looking back, there has been a significant drop in momentum as stocks have consolidated over the past year. This has resulted in a downtrend in 2022. It’s hard to get excited about the chart right now, but I’d be a bearish buyer towards the low-mid $80s.

XLI Weekly Chart: February 2020 Support and Clearance Gap

The essential

The industry is a complex sector. There are various industries that do issue a single call however. Nonetheless, I’m a short right now, but would buy the dip down to the $80 mid based on the charts. Also, the PEG ratio looks strong here given the expected strong EPS growth (and yes, we don’t know what the “E” will be).