A Look at the Risk Off Gauge That Correctly Signaled the 2000 and 2007 Tops

Here is a look at an indicator that has the distinct reputation of signaling the 2000 and 2007 meltdowns. This indicator obviously has a decent track record, but is today’s environment the same is in 2000 or 2007? Is another crash likely?

Here is a look at an indicator that has the distinct reputation of signaling the 2000 and 2007 meltdowns – the XLY: XLP ratio.

XLY (Consumer Discretionary Select Sector SPDR ETF) represents a dynamic and economically sensitive sector of the S&P 500.

XLP (Consumer Staples Select Sector SPDR ETF) represents a stable, boring and supposedly recession proof sector of the S&P 500.

The XLY:XLP ratio shows which sector investors prefer, and as such serves as a historically accurate risk on/risk off indicator.

The first chart plots the S&P 500 against the XLY:XLP ratio (I’ll call it XXR from here on). The green lines show that XXR respects trend line support.

In fact, a break below this trend line support in 2000 and 2007 is what foreshadowed trouble for the S&P 500 (SNP: ^GSPC).

This week, the XXR is exactly at trend line support once again. Extrapolating the past into the future would suggest another meltdown (assuming XXR will go on to drop below support).

However, there are some differences.

The second chart adds the percentage of bullish investors polled by AAII into the equation.

For the past several weeks the Profit Radar Report has been pointing out that retail investors along with the media (or investors influenced by the media) have turned quite bearish.

For example, when the S&P traded around 1,860 on May 7, the Profit Radar Report stated that: “The weight of evidence suggests the onset of a larger correction in May, but we are not the only ones expecting a correction. A false pop to 1,900 – 1,915 would shake out the weak bears.”

Last week’s spike to 1,902 may have been this ‘false pop.’

Is Today’s Environment the Same as in 2000 and 2007?

I’ve added the % of AAII bulls to show that today’s environment differs from what we saw in 2000 and 2007.

In 2000 and 2007 most market participants were bullish. Today they are not.

It should also be noted that XXR’s 2007 break below trend line support came a few weeks too early and could have resulted in some annoying short-term losses as the S&P 500 (NYSEArca: SPY) staged its final rally leg.

Summary

The XLY:XLP Ratio has done a decent job foreshadowing the 2000 and 2007 crashes, but the overall environment suggests that this time is different.

There is not enough fuel (aka bullish investors) to drive the S&P 500 down substantially (more than 20%) and keep it down.

As mentioned above though, in the 2014 S&P 500 Forecast (published on January 15 via the Profit Radar Report), I projected a correction in May or June. This forecast remains valid.

Here is the key must hold short-term S&P 500 level that – once broken – would trigger further selling along with key short-term resistance:

Short-term S&P 500 Analysis

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

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Sector ‘Heat Map’ Shows Cooling Appetite for Risk

Every bull market has a certain life expectancy. Nobody knows how long this bull will live, but a look at the S&P 500 industry sector ‘heat map’ shows ‘graying around the temples’ as investors rotate out of higher risk industries.

A rising tide lifts all boats. This sounds cliché, but was certainly true in 2013.

The first chart below shows the Q4 2013 performance of the nine S&P 500 sector ETFs. Those nine ETFs are:

  • Industrial Select Sector SPDR ETF (NYSEArca: XLI)
  • Technology Select Sector SPDR ETF (NYSEArca: XLK)
  • Consumer Discretionary Select Sector SPDR ETF (NYSEArca: XLY)
  • Materials Select Sector SPDR ETF (NYSEArca: XLB)
  • Financial Select Sector SPDR ETF (NYSEArca: XLF)
  • Health Care Select Sector SPDR ETF (NYSEArca: XLV)
  • Consumer Staples Select Sector SPDR ETF (NYSEArca: XLP)
  • Energy Select Sector SPDR ETF (NYSEArca: XLE)
  • Utilities Select Sector SPDR ETF (NYSEArca: XLU)
    The ETFs are sorted based on Q4 2013 performance.

More risky, high beta sectors (red colors) like technology and consumer discretionary were red hot in the last quarter of 2013.

‘Orphan & widow’ sectors (green colors) like utilities and consumer staples lagged behind higher risk sectors.

The first chart is a snapshot of a healthy overall market. No wonder the S&P 500 ended 2013 on a high note.

The second chart shows that the tide turned in 2014. Conservative sectors are now swimming on top, while high octane sectors have sunk to the bottom of the performance chart.

This doesn’t mean the bull market is over, but the distribution of colors illustrates that investors have lost their appetite for risk (for now).

Like graying around the temples, this rotation out of risk reminds us of an aging bull market.

It’s not yet time to order the coffin, but indicators like this do warn of the potential for a deeper correction.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Weekly ETF SPY: XLV – Head-and Shoulders Above Other Sectors

The Health Care Select Sector SPDR ETF (XLV) sports the second best year-to-date performance. Recent price action has exposed a key short-term support level that can be used as a trigger level for investors looking to short the health care sector.

The Health Care Select Sector SPDR’s (XLV) performance ranks head-and shoulders above the rest. XLV is up 19.19% year-to-date, outperformed only by utilities (XLU is up 19.66%).

Other double-digit year-to-date performers include the Consumer Staples Select Sector SPDR (XLP – 17.89%), Consumer Discretionary Select Sector SPDR (XLY – 15.46%), Financial Select Sector SPDR (XLF – 14,48%) and Energy Select Sector SPDR (XLE – 10.08%).

Technology (XLK), industrials (XLI) and materials (XLB) are stuck in single digit performance territory.

Looking at the performance (and possible cracks) of leading sectors often provides clues for the overall stock market. Prior ETF SPY’s identified key support for other leading sector ETFs like the iShares Russell 2000 ETF (IWM) and SPDR Retail ETF (XRT).

Key support for IWM and XRT has proven crucial to the short-term performance of IWM and XRT. Bot sectors/ETFs bounced exactly from support.

Not all technical analysis proves correct with that much clinical precision, but XLV is at a point where key support has become visible.

The chart below shows that XLV may be carving out a short-term head-and shoulders pattern with a neckline around 46.70. This week this potential neckline coincides with trend line support.

A break below 46.70 would unlock a measured target of 45.15 +/-, which also coincides with trend line support.

As long as support holds, the up trend remains intact and we’re just talking about ‘unhatched eggs.’ Investors fishing for a price top may use broken support as a trigger level for short positions.

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Weekly ETF SPY: XLP – What Defensive Sector Outperformance Means

The defensive consumer staples sector has been outperforming the economically sensitive consumer discretionary sector. Some say that’s bearish, contrarians may say it’s bullish. Here’s what the facts say:

Defensive sectors like health care, consumer staples and utilities have been on fire. In fact, health care and consumer staples are the two best performing industry sectors of the U.S. stock market.

On paper, the strong showing of defensive sectors parallel to all-time stock market highs is odd. But let’s face it; the overall market action (meaning the QE bull market) is odd.

Defensive sector outperformance may be a reflection of investor suspicion. After all, owning defensive sectors is one way to ‘throw your hat in the ring’ without actually going all in.

To what extent are defensive sectors currently outperforming economically sensitive sectors?

The lower portion of the chart below shows the ratio of Consumer Staples Select Sector SPDR (XLP) to Consumer Discretionary Select Sector SPDR (XLY). The XLP/XLY ratio is plotted against the S&P 500 (SPY).

We see that extreme XLP outperformance (red lines) in the mid-2000s either held back the S&P or led to a major market top. Extreme under performance (green line) was generally seen towards meaningful market lows.

Currently the XLP/XLY is more or less in neutral territory.

The second chart shows XLP’s 48.62% rally from the August 2011 low (since its corresponding October 2011 low the S&P 500 gained 47.63%).

XLP nearly touched resistance going back to that low, but is trading above short-term trend line support. The behavior of RSI suggests a tired up trend. A close below green support would be the first sign of a correction. A close above the red line would likely reinvigorate consumer staples stocks.

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Sector ETF Analysis: 9 Sectors – 1 Message: Watch Important Technical Support

The S&P 500 Index is generally sub-divided into nine sectors. How the leading (or lagging) sectors behave can provide valuable forecasting insight. This article takes a look at the three leading year-to-date performers and their technical message.

The S&P 500 Index and the SPDR S&P 500 ETF (SPY) are made up of ten industry sectors. State Street Global Advisors subdivides the S&P into nine popular sector ETFs, called Select Sector SPDRs.

There are ten sectors, but they are condensed into nine ETFs as the technology and telecommunication sector are represented by the same ETF, XLK.

The first graph below provides a visual of the S&P 500 sectors and the sector allocation for the Select Sector SPDRs.

The second graph shows the year-to-date performance of each sector.

Each sector corresponds differently to economic developments and some sectors may boom while others bust. That at least used to be the case. During the 2000 decline about half of the sectors delivered positive returns, the remaining ones negative returns.

Since the beginning of the QE market, most sectors are up, just at a different pace.

Right now, most sectors are just above technical support and are sending the same technical message: Watch out how each sector performs around support. If support fails … watch out.

Let’s look at the technical picture of the three biggest and best performing sectors individually:

Technology:

The technology sector got hit hard in recent weeks. Nevertheless, as of Thursday’s close the Technology Select Sector SPDR (XLK) is up 22.48% year-to-date.

The technical picture for XLK looks plain ugly. XLK dropped through trend line support going back to the October 2011 lows (at 29.65) and the 200-day SMA at 29.19.

The technical picture for the Nasdaq-100 looks similar. December 30, 2011 was the last time the Nasdaq-100 closed below the 200-day SMA. It’s been trading above the 200-day SMA for more than 200.

Here’s a surprising factoid: Since 1990 the Nasdaq-100 had seven streaks of trading above the 200-day SMA for more than 200 days. The first close below the 200-day SMA was bearish only one time.

Owners of Rydex funds have grown very skeptical of the technology sector. The percentage of assets invested into Rydex technology funds has dropped to an all time low.

On August 5, the Profit Radar Report pointed out a similar extreme in the financial sector: “Financials are currently under loved (who can blame investors). Of the $900 million invested in Rydex sector funds, only $18 million (2%) are allocated to financials. With such negative sentiment a technical breakout (close above 14.90) could cause a quick spike in prices.”

The Financial Select Sector SPDR ETF (XLF) rallied as much as 10% after it broke above 14.90.

Even though the technical picture of the technology sector looks quite bearish, there’s reason to believe that the down side is limited. A bullish opportunity may develop soon.

Financials:

The financial sector, represented by the Financial Select Sector SPDR (XLF), is holding up much better than the overall market. The chart for XLF is a bit more decorated with trend lines as the Profit Radar Report has provided updates for XLF since it’s August 6 break out.

Immediate trend line support for XLF is at 15.65. The 50-day SMA is at 15.68. Immediate resistance is at 16.05. Aside from a break of the minor red trend line support, the recent decline hasn’t done any technical damage to the financial sector.

Consumer Discretionary

The Health Care (XLV) and Energy Select Sector SPDR (XLE) are slightly bigger than the Consumer Discretionary SPDR (XLY), but XLY outperformed XLV and XLE.

XLY is just barely holding on to its position above the trend line from the October 2011 low (at 45.60), but the 200-day SMA is not until 44.27. Support based on prior supply/demand inflection points is around 45.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.