Thursday, May 5, 2011

Defensive Stocks Sector Strength Points to S&P 500 Weakness


The recent sector strength of the Consumer staples ETF (XLP) over the Consumer discretionary ETF (XLY) indicates that money is now flowing out of a growth industry group and into a defensive sector. This action normally occurs during a period of weakness in the S&P 500.

Over the past few years, this shift in buying pressure between these two consumer sectors has provided guidance to the short term movements of the broad-based S&P 500. As models are indicating that a low in the index is expected in June, the returning performance of the defensive staples sector over discretionaries adds some additional evidence to the anticipated pullback.



Bottom line: The ratio line between XLP and XLY normally trends in the opposite direction to the S&P 500. Greater relative performance from the Consumer staples ETF (XLP) over the Consumer discretionary ETF (XLY) creates a rising line. This also indicates that money is flowing into the defensive sector. The action usually coordinates with a downward movement in the S&P 500.

Investment approach: With the S&P 500 trading on a stable 14-16 week cycle and an expected low in June (the last trough was in mid-March), this recent shift in performance from the growth sector (XLY) to the defensive group (XLP) adds additional evidence for the expected low. Investors may wish to wait on the sidelines for now and use this coming retracement as a buying opportunity.

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