Comparing Staples and Discretionary Sectors XLP and XLY

Jan 22, 2011: 8:03 PM CST

During major market moves, and at potential market turning points, it’s often helpful to look at the ratio between the “offensive” Consumer Discretionary/Retail and the “defensive” Consumer Staples sectors.

Let’s take a look at the current ratio in relation to the S&P 500’s big recent run, and then look individually at the daily charts of the Discretionary (XLY) and Staples (XLP) sector ETFs.

First, the S&P 500 with Offensive/Defensive Ratio in play:

This is the common, no frills Ratio chart you want to see when comparing the Discretionary/Staples (XLY:XLP) ratio in relation to the S&P 500.

Generally, the “offensive” Discretionary/Retail sector outperforms the “defensive” Staples sector during bull runs and then underperforms during bear runs.

One can use simple trendline analysis to see when this “ratio line” changes course, which often mark key turning points in the Stock Market itself.

Just look at the flattening or bottoming-out of the ratio from July to September, and then the ratio trendline breakout in early September that was a big clue that odds favored a higher stock market due to a break in the performance trendline of the Offensive to Defensive group.

The ratio line continued rising until December when the ratio peaked.  Though stocks have continued on higher to present day, the ratio has similarly flattened out and has not made a new ratio high – a spooky non-confirmation for the bulls.

The ratio sits precariously on the rising trendline and is threatening to break it soon – if investors do not flood more capital into the Discretionary/Retail sector stocks soon.

Pay close attention to this trendline – and of course pure prices in the stock market indexes as they challenge their daily moving averages and critical overhead resistance levels.

Now, let’s step inside these popular ETFs and note their trend structure, starting with the “Offensive” XLY – Discretionary:

In lieu of doing more detailed charting, suffice it to say price is in a major uptrend that is showing non-confirmations/divergences both in Volume and Momentum – classic caution/”watch-out” signals to note.

But, like stocks, this fund has held its rising 20 day EMA without abandon – and continues to this day.

It faces known price resistance at the $38 level and  rising 20 day EMA support edging higher, currently at $37.65.

As usual, a breakdown from the 20 EMA in such a trend sets up an immediate play down to the rising 50 day EMA ($37), and by the same logic, a price breakout through overhead resistance is a potential entry for popped stops – if the SP500 also breaks above its 1,300 barrier.

The picture is slightly different in Staples (XLP), at least on the way up:

Most notably, the XLP made a HIGHER HIGH in July (money flowing into DEFENSIVE stocks/sectors) than the Discretionary sector at their June highs.

The other major difference is that the Defensive Sector suffered a sharper, downward pullback in November, as compared with the more bullish/stable sideways pullback for Discretionary – which signaled investors were not in a rush to get too defensive.

Had the picture been reversed (a deeper pullback in Discretionary and a sideways move in Staples), this would have been a bearish development.

As it were, both funds and the S&P 500 continued on, as the ratio suggested, to new highs.

Interestingly enough, the Defensive/Staples ETF thrust to new highs this week (remember stocks pulled back) while the Offensive/Discretionary sector did not end the week at a high.

That sort of action helps explain why the ratio is falling or flattening, and if this little move continues (staples outperform discretionary), then the ratio trendline will break and it will signal that investors are taking a much more defensive posture, which would likely correlate with a deeper pullback in equities.

Keep monitoring both the Ratio in relation to the S&P 500 (particularly for a clear ratio trendline break) and of course the performance of both leading ETFs in regard to their resistance and 20 day EMA support levels for more clues.

Corey Rosenbloom, CMT
Afraid to Trade.com

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5 Comments

5 Responses to “Comparing Staples and Discretionary Sectors XLP and XLY”

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  3. Gustavo Barbaro Says:

    “It faces known price resistance at the $83 level”

    83??

    38!!!

  4. Gustavo Barbaro Says:

    “It faces known price resistance at the $83 level”

    83??

    38!!!

  5. Corey Rosenbloom, CMT Says:

    Thanks Gustavo!

    Typing error fixed.