Discretionary vs Staples Ratio Breaks 2009 Uptrend Line

Of all of the bearish developments lately in the US Stock Market, there is one important ratio that seems to be getting ignored. The spread between Consumer Discretionary stocks and Consumer Staples tells us a lot about how money managers view the market from a risk-appetite perspective. Today we are going to look at the recent breakdown in the XLY vs XLP ratio.

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If you're a long only money manager, which many large managers are, they can't go to cash and they can't get short. Their only goal is to outperform the S&P500, because that's their job, whether it makes sense to us or not. If the S&P500 goes down 50% and they only lose you 40%, they get a raise. Crazy I know, but that's the way it works. Fortunately we can be short and go to cash whenever we want. But I digress. My point is that if managers are bullish and want to outperform, they are going to allocate assets towards the Discretionary names (retail, housing, auto, etc) at a faster rate than they would towards Staples (soda, cigarettes, toothpaste, etc). If managers are fearful, the opposite would be the case.

Here is a weekly line chart of the Consumer Discretionary ETF $XLY vs the Consumer Staples ETF $XLP. There are two things that bother me here. The first is the failed breakout above the previous highs 10 years ago. Look how scary that looks. From failed moves come really fast ones in the opposite direction. And I think we're currently seeing that decline:

The second thing that bothers me is that we are now breaking the uptrend line from the late 2008 lows. This is a big break because this particular ratio led the market at the top in 2007 as well as the bottom in 2009. Notice how this ratio was already crashing in the summer of 2007, well before the S&P500 peaked in October of that year. Also, this ratio bottomed out in November of 2008, several months before the S&P bottomed in March of the following year.

This is one of the most important ratios that we look at and it's telling us to be careful. We want to see this ratio making new highs along with the market, not making new 52-week lows like it's currently doing. I think this is one that not many are talking about but should be.

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Tags: $XLY $XLP $SPY