Conflicting New Recovery Highs in XLP and XLY Consumer Sectors

Feb 28, 2010: 4:46 PM CST

While doing some weekend research, I came across an interesting development.

At first glance, I saw that the Consumer Staples Sector SPDR – XLP – was making new recovery highs (new 2010 highs).  My first thought was that this was a very bearish development that could be underscoring risk-aversion in that money is flowing into ‘safer’ stocks according to the Sector Rotation Model.

My next thought was to compare that development with its sister sector, the Consumer Discretionary/Retail Sector – XLY – to see if we were seeing weakness there.  To my surprise, I found that we were seeing new 2010 and recovery highs in the ‘risk seeking’ or offensive Retail Sector as well.

In fact, the only two sector SPDRs making new recovery highs were the ‘aggressive’ Retail Sector (XLY) and the ‘conservative/defensive’ Staples Sector.

Let’s take a look at these conflicting and strange signals from the sector rotation model, and view their respective ‘bullish’ daily charts.

First, a Line Comparison of AMEX Sector SPDRs (focusing on XLY and XLP):

StockCharts has a neat Sector Performance Tool you can use to track sector performance.

Instead of getting lost in the lines, focus on the “Staples” line (teal) and the “Discretionary” line (blue).  They are the only Sector SPDRs that are above the January 11th SP 500 peak for 2010 at 1,150.

Thus, these two ETFs are showing clear ‘relative strength’ not just to the S&P 500, but to the other sectors as well.

The reason that’s strange is because these are seen as competing sectors in the Sector Rotation Model, which asserts that in a rising/bullish environment, money is flowing into the ‘offensive’ or ‘aggressive’ sectors such as Technology, Finance, Industrials, and especially Consumer Discretionary (Retail).

The theory is that in a good economy, people will spend more, sending retail companies higher.

In a bad economy, or in anticipation of bad times ahead, consumers spend less, save money, and buy only what they need, which are listed as “Consumer Staples.”  By comparing these two sectors, you can effectively get a glimpse of fund and investor sentiment and expectations.

So what happens when they’re both sending the same signal?

Let me first state that it would be generally deemed as a bearish sign if Staples were outperforming all other sectors.

It would be seen as a bullish sign if Consumer Discretionary (along with Technology and Finance perhaps) were outperforming all other sectors.

However, what we have now is not just outperformance, by one or the other, but outperformance by both above all other sectors!

It’s an interesting yet conflicting development, and we can see how it happened on each sector’s respective daily chart.

First, let’s start with the “defensive” Consumer Staples (XLP) Chart:

Without doing technical analysis on these charts, we see that price appeared to be in a “Rounded Reversal” formation with a bearish breakdown of the moving averages… and then a sudden, stunning rally from nowhere in late February took the XLP to new recovery (2010) highs.

Normally, this would be viewed as investors taking the “safe route” and steering capital to the safer, defensive sectors.  This would be bearish for the broader market.

But wait right there!  We see almost the exact same thing in the Consumer Discretionary chart, which is where investors go when they feel an “all clear” on the economic horizon.

Next, we’ll end with the “offensive” Consumer Discretionary (XLY) Chart:

It’s the same thing!

What message are investors sending?

It’s very hard if not impossible to tell right now just by looking at the Sector Rotation model, specifically in the insights analysts normally glean from comparing Staples to Discretionary.

That’s why we should be watching each day cautiously for any signs of bullishness or bearishness, and not get caught up in bias traps such as saying “The market has to go higher because of …” or “The market has to go lower because of…”

Take it day bay day, swing by swing and navigate any ‘tricky’ or conflicting signals as they resolve one by one.

Corey Rosenbloom, CMT
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