I’m not losing any sleep fretting about a stock market plunge. I’ve got plenty of other things to worry about.
It’s because of exchange-traded funds that I can cop all those Z’s. Allow me to explain. See the chart below? It depicts the price ratio of the Consumer Discretionary Select SPDR (NYSE Arca: XLY) to the Consumer Staples Select SPDR (NYSE Arca: XLP).
XLY tracks the collective performance of more than 80 companies in the entertainment, restaurant and home improvement sectors. You know, the outfits that get your leisure time money. XLP, a compendium of more than three dozen stocks issued by companies including drug stores, household and personal care product manufacturers as well as food and beverage makers. XLP’s companies likely tap your wallets on a weekly if not daily basis. Both XLP and XLY are sector carve-outs from the S&P 500 Composite.
You can probably guess the relationship between the two funds. Discretionary money gets spent when folks are fairly confident about their personal economies. When they’re struggling financially they’ll mostly likely spend their scarce lucre on toothpaste and groceries instead. Thus, XLY outpaces XLP in good times and lags during periods of economic distress.
As evidence, notice the precipitous drop in the ratio in 2008 and the subsequent rebound leading at bump-up against resistance at 1.6x today.
In a nutshell, the ratio moves sympathetically to the S&P 500. Generally speaking, when the ratio rises, so too does the broad market benchmark. But if you peer closely enough, you can see that the ratio tops out well ahead of a rollover in the S&P.
Oh, wait. You can’t. The S&P isn’t plotted on the ratio chart. Here, now have a look:
Look at the divergence in the trajectory of the XLY/XLP ratio and that of the SPDR S&P 500 ETF (NYSE Arca: SPY) in early 2007. The ratio faltered in February but SPY continued upward before finally succumbing in October.
See? The downturn in the ratio gave a very generous warning to stock punters back then. Now, we’re not seeing a downturn in the ratio presently. Not yet, anyway. So I’m not worried about a big stock selloff. But I’ll be keeping an eye on the ratio and I’ll let you know when my fretting starts.
Brad Zigler is REP./WealthManagement's Alternative Investments Editor. Previously, he was the head of marketing, research and education for the Pacific Exchange's (now NYSE Arca) option market and the iShares complex of exchange traded funds.