This sector could be signaling a correction

Does the market have an industrial-sized problem?

The industrials sector – which includes heavy hitters like General Electric, Caterpillar, and Boeing – is the second-weakest performer in the entire S&P 500 for 2014. The XLI, the ETF that tracks the sector, is down a fraction of a percent for the year while the S&P 500 index is up 5 percent.

But with second-quarter GDP growth coming in at 3.9 percent after a first-quarter loss of 2.1 percent, will that mean industrial stocks will soon be on the rebound?

Don't count on it, according to Erin Gibbs, equity chief investment officer at S&P Capital IQ. "We still see it as very much a 'market perform' to even a slight 'underperform' just given earnings growth," she said of the sector. "The problem is that GDP growth is a lagging indicator."

Although the second-quarter GDP number was a slight surprise to economists, there hasn't been much of a change in forward GDP growth or earnings estimates, Gibbssaid. "There may be a slight improvement with short-term sentiment, but overall we don't see a big change in what these companies are going to earn over the next year," she said. "We really see them performing very much in line with the market."

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Company-specific data could move the XLI (GE is 10.2 percent of the ETF; the top 6 companies make up 33.7 percent), but Gibbs sees the XLI moving only a bit ahead of the market.

"[The sector] is still trading at about 16.3 times forward earnings, which is exactly what the S&P is trading," Gibbs said. "We don't see a huge amount of growth going forward. It's still pretty much in line with 10 to 11 percent growth."

For Steven Pytlar, chief equity strategist at Prime Executions, the charts of the XLI agree with Gibbs that the sector will continue to move with the overall market and not much more. And he thinks there'll be a retracement.

"We see the market correcting right now," Pytlar said. "It's not surprising that we see the industrials correcting right now."

The overall trend for the XLI is still positive, said Pytlar, but he thinks it may move towardsupport at $51.35 per share.

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"We'd look for some signals that it's catching the underlying trend and that buyers are coming in around there," he said. "Given that we think the economy is trending higher, we would expect that support to hold. If it doesn't hold, then we'd have to take a look at that underlying assumption that things are slowly improving."

However, were the ETF to fall below $51.35, it could be a big warning of something else going on, according to Pytlar. "Breaking that support level would indicate that capital is flowing out of the industrials space," he said. "We'd have to move from a neutral-to-positive outlook on it to a more negative outlook."

To see the full discussion on the industrials sector and the XLI, with Gibbs on the fundamentals and Pytlar on the technicals, watch the above video.

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