The Prudent Approach to Materials ETFs

ETF Trends

In somewhat quiet fashion, the Materials Select Sector SPDR (XLB) is trading not just near 52-week highs, but at its highest levels since 2008.

Although XLB is off 0.04% this year, that performance is still good enough to rank the ETF in the top half of the nine sector SPDR ETFs on a year-to-date basis. However, materials ETFs are coming off a disappointing January, a month that is usually kind to the sector. [Two Sector ETFs for January]

The sector’s recent lethargy could be a sign XLB and rival ETFs should be approached with caution in the near-term. The charts confirm as much.

“We’ve see what some of these other sectors have done upon their breakouts (healthcare is a great example), but Material prices have yet to prove they can absorb all of this overhead supply. I think it’s worth waiting for. Shorts, on the other hand, can use these levels as a stop. The risk/reward is definitely skewed in favor of the bears up here in the short-term,” notes J.C. Parets of Eagle Bay Capital.

XLB’s relative strength against the S&P 500 has been slumping since late 2010 and although that situation has recently shown faint signs of improving, XLB is still a long way from being in a stronger spot than the benchmark U.S. index.

“We can see that XLB/SPY has broken above this downtrend line from 2011, yet still below all of this broken support. If we start to see a breakout back above those lows, then we can make a solid argument for a relative overweight in the basic materials space,” notes Parets.

In the six years ending 2013, XLB only outperformed the S&P 500 twice – in 2009 and 2010. At the fundamental level, materials stocks are a tad pricy compared to the S&P 500. On a relative basis, the materials sector is trading above its long-term price-to-earnings, price-to-book and price-to-operating cash flow ratios.

Dow component DuPont (DD), Monsanto (MON) and Dow Chemical (DOW) combine for about 30% of XLB’s weight. That is more than the ETF’s next five holdings combined, highlighting the importance of those three stocks to XLB’s fortunes.

Materials Select Sector SPDR

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XLB

 

ETF Trends editorial team contributed to this post.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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