Risk Measurements Are Showing Signs of Fatigue
This rally has continued to grind higher over the last two months in spite of flagging momentum. The returns have been spectacular as the 'green shoots' recovery story has many subscribers. There are still red flags all over this rally, however as the indices have managed to chop sideways for the month of June. Those of you out there who are thinking about shorting here, be very, very careful. Yes there are signs of trouble, but jumping in too soon could prove very costly. Watch the May lows for signs of a turn. if those lows come out, then this market could be in for a wicked correction since no real consolidation areas were formed on the way up which would act as support on the way down.
There are many measurements that can be used to gauge the risk level investors are willing to take on. One of my favorites is consumer discretionary vs. consumer staples. Consumer discretionary is a group that does well during times of economic expansion because purchases there are more the result of 'wants' (eating out, electronic gadgets, etc.). Consumer staples, on the other hand, are more defensive in nature because these are items that are needed such as groceries, personal care items (soap, toothpaste), etc.
The chart below shows the relationship between consumer discretionary (XLY) vs. consumer staples (XLP). When the black line is trending higher, that supports the 'good times' theory where consumers have more disposable income. When it is trending lower, that says that consumer spending is dominated by the 'need' items. There are periods where the spread will simply trend with the market. When the spread and the market diverge, however, that can provide clues as to what is coming for the market.
Notice below how the XLY:XLP (black line) spread began to break lower in early May. As the S&P 500 (red line) made a new high in June, the XLY:XLP spread did not come close to its early May high. That shows a shift in buying from discretionary to staples which means that investors are getting more defensive even as equities rise, which is not a positive sign for the bulls.
Again - this does not give us the green light to short the market in a big way, it is simply flashing a caution sign that the appetite for risk is waning. Watch the May lows for a sign that the trend is ending and that a correction has begun.
There are many measurements that can be used to gauge the risk level investors are willing to take on. One of my favorites is consumer discretionary vs. consumer staples. Consumer discretionary is a group that does well during times of economic expansion because purchases there are more the result of 'wants' (eating out, electronic gadgets, etc.). Consumer staples, on the other hand, are more defensive in nature because these are items that are needed such as groceries, personal care items (soap, toothpaste), etc.
The chart below shows the relationship between consumer discretionary (XLY) vs. consumer staples (XLP). When the black line is trending higher, that supports the 'good times' theory where consumers have more disposable income. When it is trending lower, that says that consumer spending is dominated by the 'need' items. There are periods where the spread will simply trend with the market. When the spread and the market diverge, however, that can provide clues as to what is coming for the market.
Notice below how the XLY:XLP (black line) spread began to break lower in early May. As the S&P 500 (red line) made a new high in June, the XLY:XLP spread did not come close to its early May high. That shows a shift in buying from discretionary to staples which means that investors are getting more defensive even as equities rise, which is not a positive sign for the bulls.
Again - this does not give us the green light to short the market in a big way, it is simply flashing a caution sign that the appetite for risk is waning. Watch the May lows for a sign that the trend is ending and that a correction has begun.
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