Consumer Staples (a defensive sector) still has the upper hand on Consumer Discretionary based on our readings, which coincided with unfavorable broad market returns in the past. However, the technical relationship between Consumer Staples and Consumer Discretionary is close to flipping which bulls should like to see.

The 2022 bear market ushered numerous failed rallies, and as a result, many investors are examining the current run with greater scrutiny. As frequent readers of this report and/or users of the platform know, there are a variety of technical indicators that can tell us where we are in a market and where might we be headed – often cited ones are DALI (Dynamic Asset Level Investing), the Asset Class Group Scores (ACGS), Bullish Percents, Positive Trend Readings, and Ten Week Charts. However, there are also a handful of key relationships between broad market funds and individual sectors that provide equally valid insights, one we will highlight today is between Consumer Staples and Consumer Discretionary.

To be clear, when we use the term staples, or non-cyclical, we are referring to a basket of stocks that represent companies involved in the core production of essential products used by consumers. This includes items like food, beverages, household goods, hygiene products, and even alcohol and tobacco. On the other hand, consumer discretionary stocks are representative of companies that produce goods and services considered non-essential by consumers, but desirable. Examples of these would be durable goods, high-end apparel, entertainment, leisure activities, and automobiles.

Given this distinction, Consumer Staples are often pegged as a boring sector; however, we believe the space becomes much more interesting when comparing its price movements to those of the Consumer Discretionary sector.

The image above plots the average technical score between Consumer Non-Cyclicals (Staples) funds and Consumer Cyclicals funds. In short, when the blue line is above the red line it means that non-Cyclicals are behaving better than Cyclicals; in other words, when Non-Cyclicals are scoring above Cyclicals we have quantifiable reason to believe that there is greater market demand for defensive investments. Historically, this has been an important relationship to monitor as evidenced in the bulleted points below. Note that the stats use data beginning in 2011.

• When the Non-Cyclicals group scored above Cyclicals, the Consumer Staples ETF (XLP) averaged a gain of 0.9%, the S&P 500 (SPY) averaged a gain of 0.6%, and the Consumer Discretionary ETF (XLY) averaged a loss of -0.1%.
• However, when Cyclicals scored above Non-Cyclicals XLP averaged a gain of 5.2%, SPY averaged a gain of 7.2%, and XLY averaged a gain of 9%.
• The Non-Cyclicals group has now scored above the Cyclicals group for just over 400 days, which is the longest run in our data history. The second longest run came in 2015/2016.
• The longest period in which Cyclicals scored above non-Cyclicals came between August 2012 and October 2014, at nearly 800 days.

When returning our eyes to the graph, notice that the two groups are quickly heading toward each - a move that was absent from the 2022 market rallies. Bulls should like to see the Cyclicals group overtake non-Cyclicals. Past crosses have coincided with market inflection points, so this should be a chart to watch closely.

Another look at this sector relationship is the 3.25% relative strength (RS) chart between the Consumer Staples ETF (XLP) and the Consumer Discretionary ETF (XLY). As seen below, the chart tends to “trend” quite nicely – what we mean by that is the consistency of signals. Typically, buy signals lead to more buy signals, and sell signals lead to more sell signals.

In addition to a nice-looking relative strength chart, the broader market implications of this relationship are surprisingly robust as demonstrated in the embedded performance table in the chart above. 

• When XLP was on a relative strength buy signal against XLY, the S&P 500 (SPY) averaged a loss of -6%.
• However, when XLP was on a relative strength sell signal against XLY, SPY averaged a gain of over 100%. Note that XLP gave a relative strength sell signal against XLY in April 2009 and remained on a relative strength sell signal until March 2020.
• The only period in our dataset that saw a positive return from SPY when XLP was on a relative strength buy signal against XLY was the Covid period from March 9, 2020 – April 29, 2020. Apart from that, every time XLP was on a relative strength buy signal against XLY, SPY was negative.
• Based on the current RS chart level, we would need to see roughly 16% of relative underperformance from XLP (vs XLY) to flip the signal.

For those that got turned around in the XLP, XLY, non-Cyclical, and Cyclical jargon the point is this – Consumer Staples (a defensive sector) still has the upper hand on Consumer Discretionary based on the charts presented today, which in the past has coincided with unfavorable broad market returns. However, the technical relationship between Consumer Staples and Consumer Discretionary is close to flipping which bulls would certainly like to see.