[Chart Of The Week] Consumer Discretionary vs Consumer Staples

JC Parets
January 6, 2016

Ratio analysis is one of the most valuable tools that we have as market participants. It's important to recognize where money is flowing out of, and where it is going into. This is the case when it comes to stocks, bonds, commodities and currency markets. A lot of these ratios tell us what the institutional money is doing, which is what drives markets. Think about the long-only mutual fund managers as a giant cruise ship. It takes a long time for a cruise ship to turn completely around and go in a different direction. With the amount of money being controlled by mutual fund managers, it's a similar situation. We can spot a cruise ship turning around very easily, because it takes so long. It's not much different in the stock market.

Today we are looking at a ratio of the Consumer Discretionary Sector vs Consumer Staples. The reason this is important is because of the high correlation between

this particular ratio and the S&P500.

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Here is the chart of the ratio putting in a failed breakout above the highs from the past 2 years and quickly reversing course. The old saying is that from failed moves, come fast moves in the opposite direction. In this case much lower:

The problem here for the U.S. Stock Market bulls is that this ratio tends to be a great leading indicator for the direction of the S&P500. Go back and look. This ratio peaked in the Summer of 2007, right before the S&P500 peaked in the Fall of that year and then crashed. The ratio once again led in 2008 and put in a bottom in November, several months before the S&P500 eventually made its final low in early March of 2009.

The reason this is important is because think about it: Long-only mutual fund managers with an S&P500 benchmark have a mandate to outperform it. That's it. They can't go short and they usually have to be almost fully allocated. So sector rotation is their hedge. If times are great, the economy is booming, and managers want to speculate, they're going to put money into discretionary names like Homebuilders, Automobiles, retailers, etc at a much faster pace than they would into consumer staples that we will buy regardless of the economy: Soap, cigarettes, soda, beer, etc. When managers want to hide in safer places, they will put money into staples at a much faster pace than towards discretionary. This shift in allocation takes time, like a cruise ship doing a 180. We can spot this shift in allocation by watching this ratio.

Here is the Disretionary vs Staples ratio with the S&P500 plotted behind it.

I'd be watching this ratio closely folks. It's heading lower and likely dragging the S&P500 down with it!

 

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Tags: $XLY $XLP $SPY

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