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Cons. Discrectionary/Retail In Decline?

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As the 2011 trading year unfolds, it is rather clear that the consumer discretionary sector and retail in particular are showing a tendency towards declining rather than rallying with the overall broader market. This is change from the past 2-years, where the consumer discretionary names have out-performed rather than handily. Therefore, this interests us from a trading perspective, for although we may not want to outright short these names, then we certainly want to be under-weight them and/or short them versus another sector such as Energy.

To this end, we've illustrated the S&P Energy/S&P Consumer Discretionary ETF ratio. And what we see is rather interesting and bullish. Interesting in the fact the ratio is trading at mid-2006 levels, which was at the height of the housing-bubble home equity extraction period that fueled large amounts of frivolous buying. Thus, given today's challenged consumer environment, then it would appear the discretionary stocks are a bit overextended in absolute terms, and overvalued versus energy. But given the chart is XLE/XLY, then it means that XLE should gain rather nicely against XLY in the weeks and months ahead.

Hence, we are buyers of the ratio, and we'll do so via the individual shares in each group as it is far easier to put on given the ability to find XLY shares to be short. But for our interests, the ratio clearly illustrates our point.

Xle_xly 1-8-11

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