(click to enlarge the chart)
This ratio line
shows how economically sensitive cyclical stocks and the more defensive staples
compete for investor funds. In addition it tells us something about consumer
sentiment and the strength or weakness of the economy.
Cyclical stocks usually
do better when the economy is on the upswing and worse when it is in decline so
the direction of the ratio line tells us something about the direction of the
economy - or at least what the markets expect for the economy.
The ratio bottomed
in march 2009 and then rallied along with the broad market (SP500) until Q1
2011 – thus indicating renewed confidence into the new monetary revolution organized by the Fed and
its attempt to revive the economy. Then it peaked in early 2011 (5 months ahead of the SP500) as money flowed out of economically sensitive cyclical stocks
into economically resistant consumer staples.
It was a sign that investors were
already starting to question the fed’s policy real benefits for business and
were anticipating some potential upcoming economic
weakness. Since that date, QE2 and QE3 fueled other intermediate rallies in equities but failed
to convince investors that a sustainable recovery was under way as the ratio line
went sideways for an extended period of time.
Now it stands again at a very interesting
threshold: just beneath its resistance line. If it breaks up its 18-month trading
range (extending back to early 2011), it will imply that cyclical stocks have
gained clear dominance over staple stocks for the first time in 2.5 years and will
provide a very encouraging sign about the reality of the upcoming U.S recovery. This
type of sector rotation would be a good sign that the market is becoming
really optimistic about the direction of the business.
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