Relationships Matter

While price movements are the ultimate determinant of market health, assessing relationships between key fundamental measures will give clues as to underlying strength, or weakness.

There can be no healthy equities market without an underlying healthy consumer market.  Consumption drives demand, which drives production which drives raw materials, which translates into economic growth.  During these times of general prosperity, demand for all kinds of consumables is elevated, from phones to exercise machines to NFT tokens.

Conversely, when confidence weakens for consumers, they reduce consumption of disposables, or non-durables.  Instead, there is more of a focus on safety and staple items.   A way to measure this confidence is to chart the two reference proxies of the XLY etf vs the XLP etf.  XLY measures a basket of consumer discretionary select issues, whereas XLP measures a basket of consumer staples.

The following two charts illustrate the dynamic that was taking place during the latter part of 2021.  In the first chart, we notice the overall stock market, as measured by the SPY etf was pushing towards new highs even as a momentum statistic was diverging.  I highlight December 10th as a reference point for clarity.

The chart below shows the path of the XLY divided by XLP.  When the chart is ascending, it means that people feel confident and are buying consumer discretionary items in favor of staples.  When the chart is descending, people are not as confident and thus put money into issues of relative safety.

We notice that on the December 10th date, there was a divergence between the SPY and the XLY:XLP charts, hinting that things were not all swell with the stock market as a whole.

As it turned out, this December period marked a high point for the stock market’s long ascent.  We’re now almost into the 7th month of the subsequent downturn.  For any longer term recovery to occur, it will be necessary to see an improvement in the XLY:XLP statistic which will be a strong hint that consumer confidence has returned.  Investors will have to determine whether the economic variables are friendly to move back into consumer mode.

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