Today is a tale of two cities for industrial stocks, with General Electric (GE) trading up about 2.5% and at both a new 52 week and 7 year high after posting better than expected Q3 earnings. On the flip-side, Honeywell (HON) is down about 2.5% after reporting disappointing results and guiding down for the balance of the year. Both companies have been aggressively cutting costs, shedding non-core assets and buying back a ton of stock to help massage earnings during a period of their first annual sales declines since 2009. Both stocks are large components of the Industrial Select etf, the XLI, making up a combined 15% of the weight. In addition to poorly performing industrial stocks like CAT, MMM & UTX, it is chock full of transports like FDX, UNP and UPS. This etf should be ground zero if and when the next market meltdown happens as its components have suffered from dollar strength and weak emerging markets.
The XLI looks to be in a massive technical topping out phase. It hasn’t kept pace with the broad market and topped out very early this year, in February. The etf sits just above two important support levels. The uptrend that has been in place since the financial crisis lows and near term support at $50. A break below both for the third time in just a couple months could mean a move lower as far as the mid $40s:
Options prices are relatively cheap compared to its individual components, (as it should be as the etf lacks the idiosyncratic risk of the individual stocks) but with 30 day at the money implied vol down at 16%, options on the XLI are cheap after its sharp bounce as we head into the meat of Q3 earnings:
Our Take: GE, the largest component in the XLI has masked a lot of poor performance from its peers. I fully expect most earnings and guidance from components yet to report to resemble HON more than GE. A lot of what’s going on with GE is stock specific.
I want to make a defined risk bearish bet over the next couple months that the XLI will re-test its August lows:
Trade: XLI ($52.40) Buy Dec 52/48 put spread for $1
-Buy to open 1 Dec 52 put for 1.40
-Sell to open 1 Dec 48 put at .40
Break-Even on Dec Expiration:
Profits: up to 3 between 51 and 48, with max gain of 3 at 48 or lower, break-even down about 2.5%.
Losses: up to 1 between 51 and 52 with max loss of 1 above 52, or about 2% of the stock price.
Rationale: GE is trading at highs for stock specific reasons, not improved fundamentals. We expect most industrial and transport stocks to continue to struggle and lead the rest of the market lower into year end. XLI options are relatively cheap, offering a way to define risk and play for continued technical deterioration.