On Thursday, 37 exchange traded funds touched new all-time highs. In what may be a cautionary tale for the veracity of this week’s equity market bounce, at least five of the members of Thursday’s all-time high club were consumer staples ETFs.
One of those ETFs Consumer Staples Select Sector SPDR (NYSEArca: XLP). It may not appear troubling that XLP, the largest consumer staples ETF touched a record high Thursday and that the fund is up 2.7% year-to-date. However, investors can gauge the potential for a broader market pullback by measuring XLP against the Consumer Discretionary Select Sector SPDR (NYSEArca: XLY). Unfortunately, XLY, the largest consumer discretionary ETF, is down 1.7% to start the year.
The quick explanation of the staples/discretionary ratio is that investors, excluding those that want to see equities fall, want to see the ratio falling because that means markets are favoring the higher beta discretionary sector over its staples counterpart.
For a good portion of the time since the March 2009 market bottom, the XLP/XLY has been cooperative and conducive to increased risk appetite, but there have been periods when the ratio has signaled reduced risk was the way to go and that could be the case again now. [Staples/Discretionary Ratio Spins a Cautionary Tale]
“When XLY underperforms XLP, it means that people are getting defensive. This ratio, more often than not, turns down before a correction in the overall market,” according to Captain John Charts.
That presents investors with the opportunity to be long XLP and short XLY, or for the adventurous, get long the ProShares UltraShort Consumer Services (NYSEArca: SCC) in conjunction with a long position in XLP. SCC attempts to deliver twice the daily inverse performance of the Dow Jones U.S. Consumer Services Index, the benchmark for the iShares US Consumer Services ETF (NYSEArca: IYC), which is also a discretionary ETF. [Consumer ETFs are Winning]
There are other considerations that bolster the long staples/short discretionary thesis. From Captain John Charts: