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Clear Warning Sign for SP500 from Consumer Staples and Retail Charts

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If history repeats as it did in 2011, then we should heed the message of caution from the Consumer Discretionary/Staples Relative Strength Chart.

Let’s take a look at the current message and compare that to a very similar pattern from 2011.

Consumer Staples and Consumer Discretionary XLP XLY with SP500 SPX Relative Strength

The chat above shows the S&P 500 Daily Chart in a strong uptrend into the 1,900 index level.

Beneath the chart are the XLY (green) which is the Consumer Discretionary (think “Retail”) sector which tends to outperform during good economic times and the XLP (red) Consumer Staples Sector fund which tends to outperform during challenging economic times.

We can compare these individually or we can simplify the chart by plotting the Relative Strength Line which shows changes in the relationship clearer on a line graph.  That’s what I’m showing on the middle panel labeled “XLY:XLP” which gives a clearer picture of the relationship.

When the line is rising (as it has during the majority of the bull market), the “Risk-On” Discretionary Sector is outperforming the “Risk-Off” Staples Sector and a rising line suggests “all is fine” with the market.

However, a reversal and decline in the relationship highlights out-performance in Staples or the Defensive Sector which then suggests “all is not well” and that caution should be our main focus.

We see a rising relationship throughout the duration of the chart, only to see a clear trendline break and downward reversal in March.

Since then, Staples have outperformed Discretionary (which we can see very clearly on the red line chart of the XLP – note the straight-up angle higher).

The implication is that money is flowing into more defensive names as a potential protective or cautious shift taking place behind the scenes of the market (meaning you won’t see this shift if you only look at the price of the index at all-time highs).

We can rewind the chart to the most recent time we saw a similar shift in money flow that took place in 2011:

Consumer Staples and Consumer Discretionary XLP XLY with SP500 SPX Relative Strength

Pay attention to the blue highlighted region in both the current chart and the 2011 historical chart to see the picture is very similar.

The Relative Strength or Relationship line (black) peaked near March 2011 and trended down all the way through June 2011.

We even see a similar power-rally straight up in the Defensive or Consumer Staples (XLP – red) Sector just like we’re seeing now.

We can even spot a similar sideways rising rectangle or sideways consolidation pattern that developed over the course of six months ahead of a collapse in stock prices going into August 2011.

Keep in mind that history never repeats in the exact same way, but we can draw parallels and probabilities about our current market by studying recent history of similar instances.

One additional comparison was that stimulus from QE2 ended in June 2011 and we’re currently seeing a stable reduction in monthly purchases in QE3 – another similarity (reduced stimulus occurring in an overextended market rally).

Again, this signal is one of caution, not outright panic, but study the comparison and potential outcome of the current market which could be a downward swing should history repeat.

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Corey Rosenbloom, CMT
Afraid to Trade.com

Follow Corey on Twitter: http://twitter.com/afraidtotrade

Corey’s book The Complete Trading Course (Wiley Finance) is now available along with the newly released Profiting from the Life Cycle of a Stock Trend presentation (also from Wiley).


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