Consumer Discretionary/Staples Ratio: Beware of Divergences

Historically, the ratio between consumer discretionary stocks and consumer staples stocks has been a reliable indicator for measuring investor risk appetite in the market. The concept is pretty simply, in that when investors are “hungry” for risk, they will favor higher beta names in the discretionary sector, and thus the ratio line will move up. Historically, as the market moved to higher grounds, the ratio followed suit.  But alas, we are starting to witness a divergence in that the market is continuing to grind higher but the ratio isn’t playing ball and making a series of lower-highs. We obviously can’t not ignore the impact that that treasury yields have on this ratio and with the 10-year falling off a cliff, consumer staples names are becoming more favorable for their dividends.

We witnessed a similar divergence beginning back in 2005 that lasted for 2 years while the S&P 500 continued to move higher.  Back in 2005, if you had sold at the first sign of a divergence, you would have missed a subsequent 25% or so gain before the market crashed few years later.  Overall, the ratio has been a decent precursor to major moves, buts it’s not fun sitting on the sidelines watching the market grind higher either.

The graphs below compare the discretionary/staples ratio, S&P 500, and 10-year yields over two separate time periods. The blue line represents the time period of 2012 to present day. The orange line is a historical look between 2003 to 2008. 

Tom PsarofagisComment