EC Ooops! Your Ratio’s Showing

Have you bought toothpaste recently? Or perhaps recommended the purchase of America’s largest toothpaste manufacturer, The Proctor & Gamble Co. (NYSE: PG)? 

If you answered yes to either question, you’ve contributed to the slippage in a significant indicator of consumer – and investor – confidence. You see, PG is the largest component in the Consumer Staples Select Sector SPDR (NYSE Arca: XLP), an exchange-traded fund that also holds shares of Colgate-Palmolive Co. (NYSE: CL), Kimberly-Clark Corp. (NYSE: KMB) and Costco Wholesale Corp. (Nasdaq: COST), and 29 others. These companies make or sell goods that you must buy. That’s why they’re called staples, as opposed to outfits such as McDonald’s Corp. (NYSE: MCD) and General Motors Co. (NYSE: GM) which traffic in things you’d like to buy if you only had some extra cash. MCD and GM, along with five dozen other companies, make up the index tracked by the Consumer Discretionary Select Sector SPDR (NYSE Arca: XLY).

So, what’s the indicator? Simply this: the price ratio of XLY over XLP. When the ratio increases, investors’ appetite for the discretionary sector outstrips that for staples, meaning consumer confidence abounds. On the other hand, a shrinking ratio denotes a defensive attitude toward the economy.

It shouldn’t be surprising that the XLY/XLP ratio’s been on a tear following the Great Recession of 2007-2008. The ratio peaked last summer and has since been consolidating in an ever-narrowing range.

We’ve fretted about the ratio’s rapid ascent in this space before, most recently in a column pointing to a handful of other worrisome signs.

Well, last week the ratio broke down from its wedge pattern and gave us a downside target. Chart 1 shows the technical formation. From its 2.20 peak last June, the ratio now seems e headed to the 1.64 level, an area last visited in the fall of 2017. In other words, two years’ worth of upside is at risk. And that means the broader market’s likely to get dragged down, too.

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Disclosure: None.

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