From the desk of Steve Strazza @Sstrazza
Thank you to everyone who responded to this week’s mystery chart.
There was a nice diversity of responses. Many said they were anticipating a break of the support line and would get short against that level while others were buyers as long as prices held above it. But the majority took a neutral approach, preferring to wait for the current range to resolve before having a directional bias.
A sound argument could be made for any of these answers in my opinion, so with that as our backdrop let’s take a look at this week’s chart.
The chart in question is the Aerospace & Defense/S&P 500 (ITA/SPY) ratio which has been consolidating in a sideways range for over 2 years now. While Aerospace & Defense hasn’t been an outperformer of late, it has trended consistently higher relative to the broader market since its inception back in 2006.
Whenever in doubt I like to zoom out and identify the structural trend, which in this case is undeniably higher over the long-term.
Click on chart to enlarge view.
The Aerospace & Defense subsector is also in a long-term uptrend vs Industrials, and unlike its rangebound action relative to the S&P 500, recently made a new high, cementing it as one of the strongest groups in the space.
On an absolute basis, Industrials and Aerospace & Defense both just made fresh all-time highs…which we know is not a bearish development.
However, when you look at Industrials’ trend on a relative basis, it recently broke to its lowest level in over 10-years against the S&P 500. As long as prices remain trapped below this former support at 0.254, then the risk remains to the downside and Industrial underperformance will continue.
Aerospace & Defense makes up almost 30% of the Industrials Sector SPDR thus driving much of its performance. For this reason, both ITA and XLI are likely to resolve in the same direction relative to the S&P… whether Aerospace & Defense catches down to Industrials, or if Industrials play catch up to Aerospace & Defense remains the question.
Under the latter scenario the recent low in XLI/SPY is likely to become a failed breakdown or bear trap, which would prompt us to look for long setups in the Aerospace & Defense subsector.
The bottom line is this is a potential inflection point for both the Industrial sector and its leading subsector, Aerospace & Defense. Keep an eye on them in the days and weeks ahead.
How do you think this scenario will play out? Let us know.