Costco – The Stock Is Sending A Warning Message

The reason for this scenario to come to an end is rising interest rates and inflation have a negative impact on consumers’ spending power. The outcome is slower growth in demand resulting in unwanted inventory accumulation.

There is a point when business finally recognizes the economic landscape has changed and inventories need to be cut by reducing production. 

The implication is buying raw materials needs to be curtailed, the workweek needs to be cut, and borrowing must also be reduced. These decisions will cause lower commodity prices, slower growth in wages, and lower interest rates. This is the time the business cycle transitions into Phase 3.

Beginning in Phase 3, sectors outperforming the market are utilities, staples, real estate, and bonds.

The current position of the business cycle is in Phase 2. The recent sharp rise in inflation, commodity prices, and interest rates suggests we are close to the Phase2-Phase 3 turning point.

The price pattern of Costco compared to the S&P 500 is particularly telling because it might give further information on the position of the business cycle.

Source: StockCharts.com, The Peter Dag Portfolio Strategy and Management

The above chart shows two panels. The graphs in the above panel represent the ratio between COST and SPY. The second graph is its 200-day moving average. The graphs rise when COST is outperforming SPY. The graphs decline when COST underperforms SPY. Investors are going to outperform the market if they invest in COST when the graphs rise.

The bottom panel shows the spread between the ratio COST/SPY and its 200-day moving average. The resulting pattern is unique and quite interesting.

The first feature is the spread has now reached “oversold” levels (red horizontal line), signaling the beginning of a period when COST outperforms the market. 

Source: StockCharts.com, The Peter Dag Portfolio Strategy and Management

The second intriguing feature of the graphs is the spread is closely related to the business cycle as shown by the above graph. The spread between COST/SPY and its 200-day moving average is shown in the upper panel.

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