What is the Strength in Staples Telling Us?

The stock market has a tendency to lead and look forward. So when it speaks I try my best to listen. Most recently we've been noticing unusual strength out of the consumer staples sector. This is generally where money flows when managers are looking for less volatile, "safer", areas to allocate capital. This can normally be seen on the relative charts when compared to the S&P500, not just on an absolute basis.

Here is a chart of the Consumer Staples ETF $XLP relative to the S&P500 going back a year. There are a few things on this one that I think are worth pointing out. First the obvious: look at all of the downtrend lines you can possibly draw being broken to the upside. With that, we are also seeing a bullish momentum divergence as RSI put in higher lows in early October as the relative prices made new 52-week lows:

Next, let's talk about the implications of such a breakout. Put yourself in the mind of a big fund manager. And I don't mean me slinging around just millions, I'm talking about the monster multi-multi-billion dollar fund manager that HAS to allocate assets into stocks and cannot, by charter, have more than just a small amount of cash on the books. If and when that manager gets nervous, it's like turning around a huge cargo ship, it takes time. So money begins to flow into the "safest" stocks in Consumer Staples. These companies consist mostly of goods and services that should maintain demand regardless of economic conditions. In other words, we're still going to brush our teeth, wash our dishes, drink beers and smoke cigarettes no matter what happens to the economy. These are the consumer staples.

So look at the chart above and notice how the peak in Staples vs S&P500 came exactly on the day that the monster rip-your-face-off rally in stocks got going on April 19th. I remember that day specifically because my good friend Alex Tarhini was calling out the fact that everyone was bearish and expected a collapse in the market (myself included) and what occurred was the exact opposite. Alex nailed it, but so did the XLP/SPY chart. Prior to that day, while staples were outperforming, S&Ps had essentially been flat for over two months. Then, when they got the squeeze on, staples on a relative basis got smoked.

So here we are now hitting all time highs in the stock market and everything is, "both hunky and dory". But staples are starting to perk up on a relative basis. Should we listen?

Tags: $SPY $XLP $SPX