Clues From Consumers

From the desk of Steven Strazza @Sstrazza and Grant Hawkridge @granthawkridge

Outside of the large-cap averages in the US, most stocks have been stuck in sideways trends for much of 2021. We’ve seen breakouts fail in both directions over the past two months, as sloppy price action continues to govern the broader market.

As we discussed in our last intermarket post, this range-bound action has not just been the case for stocks on an absolute basis. We’re seeing the same thing from commodities, cryptocurrencies, and even our risk-appetite ratios. Risk assets have simply been a mess.

Let's take a look at one of our favorite risk-appetite ratios, as there's been an important development in the discretionary versus staples relationship. 

Here is large-cap consumer discretionary $XLY versus consumer staples $XLP: 

Notice how this ratio was rallying aggressively coming into 2021. Now think back to what stocks and other risk assets were doing during this time. Everything was working, right?

Consumer discretionary stocks include things like retailers, automobiles, and housing stocks. These are all businesses where consumers go to spend their discretionary income. And when these groups are leading, there tends to be strength in the global economy and risk-seeking behavior in markets. Long story short, this ratio moving higher is bullish.

But the ratio stopped going up and began to consolidate in a range in Q1 of this year. So did most risk assets. Sideways has simply been the theme for most of 2021. 

Let’s focus on the most recent price behavior now. In October, XLY/XLP made an aggressive push higher. So did small-caps and many other stock market sectors and indexes. But, just like stocks, this ratio has now failed to hold its new highs and is right back in its former range. 

Here's a look at the ratio overlaid with small caps in order to illustrate the point we’re trying to make. 

They look the same. Therefore, bulls want to see this ratio repair the recent damage.

But, in recent weeks, we’ve seen some risk-off and defensive positioning take over as consumer staples have taken on a leadership role…

Consumer staples are things consumers will spend money on regardless of economic conditions… toothpaste, laundry detergent, food, beer, even cigarettes. Stocks that fall into this category, such as Procter & Gamble, Pepsi, and Mondelez, have broken out to fresh all-time highs and are currently some of the best-looking charts out there. This is something we haven’t seen in a long time.

Now let’s be clear: These are still stocks. They're supposed to participate and go up during bull markets. This is normal. What’s not normal during bull markets, though, is seeing them outperform for any significant period of time. And it’s starting to look as though this is happening today.

It’s not often that we rave about the strength and breakouts from staples stocks. But, internally, we’ve been doing a lot of that in recent weeks. With such strong breadth from this group, and with the indexes themselves breaking out of consolidations to fresh all-time highs, we’re making the bet these trends continue higher on an absolute basis.

The real question we’re asking ourselves is whether this strength will flow through to the relative trend? The S&P vs staples ratio was at its highest level since 2000 not long ago. But after a swift drop in recent weeks, it’s already back to fresh multi-month lows. If these stocks are in for a fresh up-leg on absolute terms, there is a good chance the relative trend continues to turn in their favor.

And what would that mean for the broader market?

If this is the case, we’d expect stocks to be under further pressure.

It’s still too early to call either SPY/XLP or XLY/XLP a trend reversal, but there are definitely signs that these are potential topping formations. 

Just like stocks, we want to see these risk appetite ratios reclaim their first-half highs. This would be supportive of higher prices and upside resolutions for risk assets.

But the way things currently stand, we’re still range-bound. That is as true today as it has been all year, as more and more trends seem to be failing in either direction and reverting back to their sideways action. Messy for longer remains the pain trade. We’ll know this is changing only when we start to see more charts breaking out of their ranges.

The relative trend in discretionary versus staples is simply one of many charts suggesting further consolidation right now. It's also telling us that investors are shifting more and more toward a defensive posture.

Because it's such a valuable measure of risk appetite, we want to pay close attention to it here, as whichever direction it eventually resolves in will give us a nice heads-up for the future path of stocks and risk assets.

Are you playing more defense along with other market participants these days? Let us know what you think!

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