In 1613 Sir Thomas Overbury wrote "All the carnal beauty of my wife, is but skin deep."
The popular phrase implies what we see on the surface is usually just a small part of the whole. The saying warns us that beauty will eventually fade through time, but some traits, such as personality, experiences, and intellect, last a lifetime. This beauty is as true with ETFs as it is with people.
An ETF on the surface may look great, but once the traits of the fund such as the holdings, weightings, and risks are known, it may not be near as pretty as a surface glance suggests. For the Industrials Select Sector SPDR ETF (XLI - News), this is especially true. One glance beyond the surface reveals a some ugly realities.
Some Quick Facts: The Dow Jones Industrial Average recently made new all time highs. However this has been old news for the more "pure play" Industrial sector ETF, ticker XLI. For XLI, that new high occurred in late December as it surpassed its 2007 $37.43 price high and continues to make new highs today.
The Industrial sector has led the broader S&P 500 since the November 2012 lows, up 21% versus an S&P's gain of 18% as it makes up over 10% of the S&P 500 by market weight.
Industrial Sector Weightings Most investors are aware of the immense size of Apple (AAPL - News) in the Technology sector (XLK - News). But many are not aware that the Industrial Sector has a very similar makeup, making it the second most concentrated of the Sector ETFs (behind Technology).
The S&P 500's Industrial sector as of 5/31/13 was made up of 61 companies and weighted based on market cap. The top 10 Industrial companies out of the 61 make up a full 49% of the XLI's market cap.
Furthermore, 5 stocks constitute 31% and just 3 stocks make up over 22% of the XLI's value. But that isn't what makes the XLI dangerous. The top company in this sector takes the next 3 companies added together just to surpass its weight in the Index...and that creates concentrated risk. What is this mystery company?
The spreadsheet below captures the breakdown of the Industrial sector by market cap weighting of the top 10 companies in the index. General Electric (GE - News) accounts for 12% of the index's movements, and is the proverbial gorilla in the room.
Beauty is Indeed only Skin Deep The chart below shows the top five index constituents that make up 31% of XLI's weight and displays the difference in performance among these five Industrial companies. Since the November lows, only one of the top companies in the sector, Boeing, has significantly outpaced the other Industrial companies. The next three largest companies have also outperformed, up around 25% since their November lows. If all these companies are up over 25%, why is the index still stuck at only 15% returns?
Primarily because of GE which is shown by the green line with only a 12% return.
With such a large concentration of weight in just one company, investors and traders likely should focus their attention on General Electric to forecast this index's movement. Although four of the largest companies in the index are significantly outperforming the index as a whole, the gorilla in the room, GE, is dragging the index down.
Apple and Tech were in a Similar Situation We were able to do a similar analysis on the tech sector, and Apple's dominance in it, to help suggest selling Apple on 3/24 just before it tanked from $460 to $390.
In "Can Apple Regain its Mojo" written on 4/1/13, I talked about Apple's dominance in the tech sector and the technical warning signs it was presenting then. (Also see our recent video, "Is Apple's Decline Almost Over?"
As such a huge component of the index, Apple's role in the Tech sector for better or worse is similar to GE's in the Industrials.
What GE is Telling Us GE has been and remains in an uptrend since the 2009 lows, but caution is warranted as price has again reached a recognized technical resistance level at $24 and shown in the next chart below.
At the bottom of the chart, the relative strength analysis between GE and the Sector ETF, XLI, shows that since the 2009 lows, the two have barely outperformed or underperformed each other and proves that GE will likely tell you most of what you need to know concerning the Industrial ETF's price movements. Where GE goes, the ETF follows.
The bottom section of the chart also shows that in early 2008, GE started showing relative weakness as it underperformed XLI. That was a clue that GE was leading the index lower. If a similar relative weakness starts to occur, it would likely again be a sign that GE's non-industrial exposure is leading the index into trouble.
Finally, a break of the short-term uptrend in price (shown in red) would be the first clue that a change in trend is likely occurring. If that coincides with a relative strength breakdown, it would only add to the evidence that GE will be leading the XLI down again. Until that occurs the trend remains up, but caution is warranted at these price levels.
The ETF Profit Strategy Newsletter uses relative strength analysis along with common sense technical and fundamental analysis to provide a short, mid, and long-term forecast along with actionable buy/sell recommendations. This helps us identify key trend changes in the sectors as well as the broader markets such as Treasuries, Currencies, and Commodities.
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