A Recovery Is Shaping Up

Those hoping for a “V”-shaped recovery from the March stock market nadir have nearly realized their dream. The S&P 500’s rebound has been a bit a more ragged than its descent--it’s taken twice as long for the index to get within reach of its February high--but it’s been a remarkably exuberant revival.  

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Perhaps too exuberant. That could be reasonably inferred, anyway, from that stalwart barometer of investor sentiment, the XLY/XLP ratio. You probably know the ratio by now. It’s the quotient derived from dividing the price of the Consumer Discretionary Select Sector SPDR (XLY) by that of the Consumer Staples Select Sector SPDR (XLP).

XLY owns all those companies that make or supply the things you’d like to have--such as General Motors (NYSE: GM), Tiffany & Co. (TIF), and Royal Caribbean Cruises Ltd (RCL)--while XLP’s outfits provide the goods and service you must have. When you think of XLP, think Procter & Gamble Co. (PG), Kroger Co. (KR), or Clorox Co. (CLX).

The XLY/XLP ratio rises as confidence in the economy flourishes and slumps as faith in future prosperity dwindles. It tends to move ahead of the broad market indices, so it has predictive value. Recently, the ratio’s been turbocharged--on the way up and on the way down. You can see this in the chart below.

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The ratio’s been a roller coaster for nearly three years. It peaked in mid-2018 after an eight-month climb and ultimately broke its decade-long uptrend line when the COVID outbreak reached U.S. shores. Now the ratio’s above its pre-virus level and seems intent on challenging its all-time high.

Such precipitous moves often prove to be disappointments for traders, though. They tend to be overshoots. Realistically, some backfilling should be expected before a new high is scored. That red downslope line on the chart may very well get tested as support for the ratio.

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