[Chart Of The Week] This Sector Could Be Flashing A Warning Sign

JC Parets
August 31, 2016

Every week I go sector by sector and start my analysis from scratch on both weekly and daily timeframes. This provides structural perspective to get a bigger picture outlook and then I work my way down to daily timeframes for execution and risk management purposes. This is what we call a top/down approach. Along the way, I also want to see how each sector is performing relative to the rest of the market. This relative strength analysis is usually a 'heads up' for what is to come on a more absolute basis.

Today, I want to focus on one of the most important sectors in the US Stock market and why the relative underperformance is something we want to keep on our radar.

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[hide_from visible_to="member"]Here is a chart of the Consumer Discretionary Sector relative to the S&P500 (XLY/SPY). To me, this looks like it is breaking the uptrend line from the late 2008 lows confirming a bearish momentum divergence at recent highs. This probably isn't a bullish sign for the Consumer Discretionary space:

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Discretionary vs S-P500 -XLY-SPY-

Now let's break things down to a shorter-term time horizon. Here is a daily timeframe of the same chart. This is the Consumer Discretionary Sector vs the S&P500 (XLY/SPY). I kept the uptrend line from the 2008 lows so you can see where we're breaking. But more importantly, since peaking in November last year, prices have been consolidating within converging trendlines putting in both lower highs and higher lows. The resolution out of this consolidation should be telling for the direction of the next move:

Discretionary vs S-P500 -XLY-SPY- d

With the 200 day moving average now rolling over and the ratio breaking down below the uptrend line from the February lows, I can't imagine this is a positive for the Consumer Discretionary sector. When you look at its top components, you see names like Amazon and Home Depot.

I would argue that further selling in this ratio above would be a negative for the sector as well as a sign that risk appetite for stocks in the U.S. might be wavering up here.

You guys know how bullish I've been towards stocks, particularly U.S. equities, over the past 2 months. It's hard to find negatives out there, but this is one of them. Stock Market bulls want to see stabilization here. If momentum can stay out of oversold conditions on the daily timeframe, that would be step 1 for the bulls. Oversold readings here would be another feather in the hat for the bears.

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Tags: $XLY $SPY $AMZN $HD

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