#$rcd

Here are some of the most noteworthy new highs and lows across the markets for Friday, December 13, 2019.

NYSE Composite $NYA Hitting New All-Time High

All-Country World Index ETF $ACWI Hitting New All-Time High

Equal Weight Consumer Discretionary ETF $RCD Hitting New All-Time High

Berkshire Hathaway $BRK-B Hitting New All-Time High

Taiwan ETF $EWT Hitting New All-Time High

Semiconductors Bounce Off Test Of Former Highs…Back To New All-Time Highs

Micro-Cap ETF $IWC Hits 52-Week High, but…

High Beta ETF $SPHB Testing All-Time High

Europe’s STOXX 600 Testing All-Time Highs $FEZ $FEU

Financial SPDR $XLF Testing All-Time Highs

Simon Property Group $SPG Hitting ~6-Year Low

If you’d like to see these charts as they come out in real-time, follow us on Twitter and StockTwits. And if you’re interested in the daily “all-access” version of all our charts and research, please check out our site, The Lyons Share. You can follow our investment process and posture every day — including insights into what we’re looking to buy and sell and when. Thanks for reading!

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While recent “strength” in the consumer discretionary sector has been widely hailed, it is not an accurate portrayal of the broad sector.

One of the data points that some market commentators have been pointing to as a bullish sign is the supposed strength in the consumer discretionary sector. Of course, when this sector is out-performing, it suggests that the consumer is on good footing -- and spending money. Such periods tend to coincide with bull markets and/or robust economic environments. That is why folks are so encouraged by the recent out-performance in consumer discretionary stocks. If only it were true.

Why do we say that? Much of the argument regarding the supposed strength in consumer discretionary stocks centers around the performance of the sector’s most popular ETF, the Consumer Discretionary Select SPDR (ticker, XLY). A look under the hood, however, reveals that much of the recent success of the ETF is owed to 4 letters: AMZN.

Yes, the stock of Amazon, which recently broke out to yet another all-time high. Why is AMZN so integral to this issue? Because it holds a nearly 11% weighting in the XLY, far and away the biggest of any holding. Thus, the recent strength in AMZN has provided a nice boost to the XLY.

Just how much of the XLY strength has been due to AMZN versus the broad sector in general? Fortunately, we have a way to indirectly measure it. We can take the Rydex S&P Equal-Weight Consumer Discretionary ETF (ticker, RCD), which weights each of its holdings equally as the name implies, and compare its performance relative to the XLY. This way, we can get a sense of the strength of the broad sector. And based on this comparison, the “strength” of the consumer discretionary sector seem to be a myth.

As this chart reveals, the relative performance of the RCD versus the XLY. has just dropped to a fresh post-2009 low.

This tells us that much of the apparent strength in the consumer discretionary sector is due to the cap-weighted structure of the XLY -- and in particular, AMZN.

Why does it matter? We like to see broad participation within a market or sector as an indicator of health. When that is not occurring, the market can be more vulnerable to weakness as there are fewer issues propping it up. Observe (on the chart) how the relative RCD performance was in freefall during the 2007-2009 decline. Conversely, it jumped strongly during the post-2009 rally and, to a lesser extent, during the 2012-2015 rally.

Besides being a red flag for the prospects of the consumer discretionary sector, and possibly the overall market, this is a good reminder to “know what you own”. That is, know the makeup of the particular fund so that you may better understand the potential reward and risk associated with it. If it is unduly impacted by just one or a few stocks, the fund may be much closer to heading in the opposite direction than one might think.

In other words, use “discretion” when selecting funds for investment.

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The relative strength of the consumer discretionary sector versus consumer staples had been a positive for stocks -- not anymore.

Some folks like to accuse us of being perma-bears, or at least one-sided when presenting market insights. Nothing could be further from the truth. Our only mission is to make and protect our clients’ assets. Therefore, our focus will go wherever the data leads us. It just so happens that the preponderance of data over the past 8 months, in our view, has been tilted to the bearish, or “risk” side of the equation.

That said, we have been willing suppliers of bullish indicators when we’ve come across them. Since May, these have primarily been found in shorter time-frame data points. One longer-term positive that has persisted, however, is the relative ratio between the consumer discretionary sector versus the consumer staples sector.

The story goes that, when discretionary stocks are leading, it is perhaps an indication of a healthy consumer in the economy, and/or that the investor community is comfortable taking on risk. Conversely, when the defensive staples sector is leading the way, it connotes the impression that investors, and possibly consumers, are assuming a “risk-off” posture.

Whether that is sound reasoning or not, prices do historically support the theory. When stocks are in the midst of a bull market, the discretionary:staples ratio tends to slope up. On the other hand, during risk-off periods (e.g., 2000, 2007-2008), the ratio has clearly pointed lower.

Over the past year, the ratio, as measured by the Consumer Discretionary SPDR ETF (XLY) versus the Consumer Staples SPDR (XLP) has exhibited mostly positive behavior. This has, in our view, been a positive consideration for stocks over that period. We pointed out such bullish developments in posts in May and December.

Although, in the December post, we did point out a very relevant asterisk regarding the ratio. The XLY was climbing on the backs of only a few mega-cap names (e.g., Amazon). Indeed, using the equal-weighted versions of the two sectors, we found discretionary stocks at a relative 4-year low. That said, as recently as November, the XLY:XLP ratio was breaking out to all-time highs. On the margin, we considered that a bullish factor for stocks. Not anymore.

As the chart below shows, the November breakout in the XLY:XLP ratio was short-lived. It has since dropped to an 8-month low in forming an apparent false breakout.

So is this a death knell for the bull market? Not necessarily. There are obviously numerous other factors that will weigh on the market’s direction at least as heavy as this one. However, for a bull market with a dwindling list of positives on which to hang its horns, this additional negative development is most unwelcomed indeed.

There are precious few support rungs left to lose before this market finally goes Kerplunk! (for you millennials, that’s the game pictured in the photo at the top of the post).

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The apparent strength in consumer discretionary stocks relative to consumer staples is a function of a few mega-cap names -- the action in the broad discretionary sector is actually much worse.

Outside of a few brief spurts, we have spent much of the last 7 months harping on the quality of the rallies in the stock market -- or even the quality of the non-rallies. As we have documented extensively, there has been a steady deterioration in the number of stocks exhibiting strength as well as the desirability of the areas that are continuing to hold up. It is generally a good thing for the broader market to see the cyclicals and lower quality names acting well. This suggests that participants, as a whole, are comfortable with the market environment and “risk-on”, so to speak, is at the fore. For the most part, this has not been the case since last spring.

One exception, however, has seemingly been the strength of the consumer discretionary sector, especially relative to consumer staples. When the riskier discretionary stocks do relatively better than the defensive staples, it has generally been a positive for the stock market. Yours truly even noted the positive implications of the action in the discretionary stocks versus staples stocks via a “relative ratio” back in June. That ratio, based on the popular Consumer Discretionary Sector SPDR ETF (XLY) and the Consumer Staples SPDR (XLP) broke out to an all-time high in June, in XLY’s favor. The indication was that discretionary stocks had never been stronger relative to staples.

While the XLY:XLP ratio did not extend itself much further following the breakout, it has been able to maintain the breakout levels ever since, indicating the strength in discretionary stocks had not waned. We took the implications of this development at face value, i.e., as a positive for stocks.

As time wore on, however, we noticed the deterioration in the rest of the cyclical space and thought...hmmm. Why was this sector, which typically deteriorates within a market environment that is weakening internally, actually exhibiting strength? Well, as you have probably noticed, we have spent quite a bit of focus on “equally-weighted” indexes and funds over the past several months. By viewing a market segment based on the equally-weighted performance of all constituents, we get a better grasp of the true strength of the segment. Conversely, when looking at a market cap-weighted segment, its performance may be unduly influenced by its very largest components, positively or negatively.

This is the fly in the ointment in the strong relative performance of discretionary stocks versus staples stocks. Looking at the highest weighted stocks in the XLY, we see a who’s who of the top equity performers this year including Amazon (10% weighting), McDonald’s (4.5%), Starbucks (4%), Nike (4%), etc. Collectively, the top 10 holdings make up 40% of the XLY. At a 10% weighting, Amazon alone takes a lot of the credit for XLY’s performance this year considering its 100%+ performance in 2015.

However, looking below the top 10 surface, we see that things are not quite what they seem in the “robust” discretionary sector. We can do this by looking at the Rydex Equal-Weight Consumer Discretionary ETF (RCD). Again, the RCD weights all of its discretionary components equally so the fund’s performance is a good gauge of the depth of strength in the sector. And based on that, things are not so hot there. Whereas the XLY traded at an all-time high just a few weeks ago, the RCD is well below its highs set in July. And as we have highlighted a few times in these pages, comparatively speaking, the equal-weight:cap-weight ratio (i.e., RCD:XLY) is at a 6-year low.

And compared to the Rydex Equal-Weight Consumer Staples ETF (RHS), the ratio just dropped to a 4-year low. That’s a far cry from the cap-weighted XLY:XLP ratio trading near all-time highs -- and perhaps a shock to those hanging their hats on the “out-performing discretionary stocks” thesis

We really don’t like to make excuses or poke holes when an indicator happens to be flashing a particular signal. We prefer to take all signals at face value. However, in this case, there is ample reason, in our view, to be skeptical of the supposed relative out-performance of discretionary stocks vs. consumer staples. The out-performance is essentially concentrated in just the upper echelon of the sector (which, by the way, is probably a solid signal in its own right). However, as judged by the equal-weighted versions, discretionary stocks are badly lagging behind the consumer staples.

Often times, things are not quite what they appear to be in the markets. Such is the case here. What seems like a positive for both the consumer discretionary sector and the risk-taking inclination of market participants in general, actually turns out to be a sector and market negative when taking a broader look. And it is likely enough evidence for us to dismiss the supposed positive message being sent by discretionary stocks.

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A popular consumer discretionary ETF became one of the few major funds to return to all-time high territory yesterday. But are a few of the bigger caps masking broader weakness in the space?

We mentioned in yesterday’s post on the recent small-cap underperformance that at any given time in the market, there will be numerous causes for hand-wringing on the part of investors. Some of the concerns prove to be warranted, others do not. And some are valid – just not right away. Today’s Chart Of The Day likely falls into that latter category. Yesterday’s post noting the lagging small-caps brought into question the quality and level of participation during the most recent portion of the October bounce. The same questions may be raised regarding even some of the leading areas of the rally, like the consumer discretionary sector.

The ChOTD shows that the consumer discretionary sector, as measured by the popular cap-weighted ETF, the Consumer Discretionary Sector SPDR (ticker, XLY), closed at a new all-time high yesterday. That fact demonstrates the sector’s current leadership as it is one of the few areas of the market to return to new high ground following the July-September correction. All is not well in the sector, however.

The chart also shows the performance of the unweighted Rydex Consumer Discretionary ETF (ticker, RCD). Unlike the XLY, the RCD is still well off its all-time high, by some 5%. As a result of this dichotomy, the ratio of the unweighted RCD to the cap-weighted XLY has been trending lower -- so much so that the ratio is actually at its lowest level since April of 2009!

So what are the dynamics at play here? It’s not too complicated. The XLY’s performance is being dominated by some of the larger stocks that represent a relatively high weighting within the fund. A peek at the ETF’s top 10 holdings and it’s easy to see why the fund has been performing so well.

These stocks represent some of the trendiest (as in, “up”trend) and trendiest (as in, popular) stocks in the U.S. equity market currently (that shared distinction, by the way, is no coincidence as stocks that trend upward for an extended period will naturally rise in popularity as well.) Each of these 10 stocks is up between 10% and 20% over the past month. Additionally, with the exception of Disney and Ford (after today), each one of them is at or within spitting distance of their 52-week highs. Considering these 10 stocks alone count for 50% of the weighting of XLY, it’s no wonder the ETF is at all-time highs. The rest of the fund’s holdings would have to be doing extraordinarily poorly to counteract the positive contributions of these top 10 holdings.

While the impact of the balance of the XLY’s holdings is practically invisible, the performance of the RCD can give us a better clue as to the general performance of the rest of the XLY’s holdings and a better gauge of the overall heath of the sector. There are 88 stocks currently in the RCD fund. None of them have a weighting larger than 1.46%. Therefore, the performance of the RCD is a more accurate representation of the health of the overall consumer discretionary sector as it essentially portrays what the average stock in the sector is doing.

So what is the average consumer discretionary stock doing? Well, judged by the RCD’s performance, the average stock in the sector is still some 5% away from its previous highs. That is a far cry from the cap-weighted XLY’s position at an all-time high. It also tells us that, at least within this sector, there is much weaker participation within the October rally than the XLY would suggest. And while this situation may not immediately put the brakes on the recent rally, sooner or later it will become a problem (as it was eventually following our August 5 post on the same dynamic).

Does this mean investors should avoid the consumer discretionary sector altogether? No. It simply means that not all stocks, or funds, within the sector are the same. So use, er, discretion when selecting investments here -- just as you would when selecting the products of some of these companies.

(Just try to choose the ones whose stock prices are going up!)

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“Happy & Sad” photo by Farrukh.

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The equal-weight consumer discretionary sector is at a relative 6-year low.

We have been harping on the deteriorating market breadth for months now. Whether it’s fewer advancing issues, fewer new highs, more new lows, less upside volume, etc., the evidence of this internal weakening has been nearly ubiquitous. And while there have been just enough strong market segments to keep the major averages afloat, even the leaders are beginning to show signs of wearing thin.  We mentioned one such “ailing general”, the Nasdaq 100, a few weeks ago (on the day that AAPL got slammed). Now we are beginning to see similar signs in the more focused sector leadership. One example of this is the consumer discretionary sector.

Consumer discretionary has been one of the stars of both the cyclical bull market as well as the recent rally since last October. Just this year, it is up roughly 10%, leading the way along with health care among the major sectors. Looking internally, however, we can see signs of weakening. Case in point: since the beginning of the year, the equal-weight average of the sector (as represented by the Guggenheim Equal-Weight Consumer Discretionary ETF, ticker RCD) has been weakening relative to the cap-weight average (as represented by the Consumer Discretionary SPDR ETF, ticker XLY). Recently, that weakening has been downgraded to a tailspin. Observe the chart:

One can see that the equal weight:cap-weight ratio peaked near the beginning of the year. Despite this, both indexes have continued to rise. That is not necessarily surprising as we often see breadth peak before prices. And the equal-weight average is really a measure of breadth as it accounts for all constituents equally. Thus, if the average is doing well, then the broad array of stocks within the sector are doing well. And conversely, if most stocks are struggling, the average will necessarily struggle too.

With the equal-weight average having peaked versus the cap-weight, we have an indication that all is not as well under the hood of the consumer discretionary sector as the cap-weighted XLY might have one believe. One may argue that it did close at an all-time high just yesterday so how bad could it be? Well, a couple recent development on the chart are concerning to us.

First off, the relative weakness of the equal-weight index has accelerated, beginning with the April break of the post-2009 UP trendline in the RCD:XLY ratio. Since then, the ratio has essentially gone straight down, closing at a 6-year low yesterday. Plus, the trouble is not just confined to the relative basis. On an absolute basis, the equal-weight RCD has failed to make a new high here in August along with the cap-weight XLY. This deserves to be monitored in coming days and weeks as a divergence here would be another red flag.

The bullish stock market argument has centered around the fact that there are still enough leaders in the market to keep it moving forward. This is an agreeable argument -- if you own the leaders. If you do not, you may be surprised at what is happening across the broad market spectrum (looking at you Mr. Diversified Equity Portfolio). We have no problem maintaining exposure to the leading segments of the market that continue to roar higher. As we see with the consumer discretionary sector, however, it should be noted that once the relatively few leaders give way (DIS is getting slammed today), there is not much of a foundation underneath supporting this market.

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Today we have 2 Charts Of The Day -- 1 good and 1 bad -- related to the consumer discretionary sector. This can be a key sector in gauging the health of both the stock market (via monitoring consumer discretionary stocks) and the economy (via monitoring consumer spending behavior. This post (as 99% of ours do) focuses on the stock side.

First, the good news. Back on  January 21, we pointed out a development of concern regarding consumer stocks. Historically, it has been bullish for the overall market when consumer discretionary stocks are leading consumer staples -- and vice versa. This makes sense as it relates to the economic cycle during bull vs. bear markets, not that the economy necessarily has to move in lock-step with the stock market. It did hold true, however, in 2000 and 2007 as the broad stock market was topping out. The performance of consumer discretionary stocks peaked early on and led the way downward relative to consumer staples. It was this same negative action that we pointed out in January as the discretionary:staples ratio was failing to make new highs along with the S&P 500. As of last week, that changed.

Specifically, the ratio between the Consumer Discretionary SPDR ETF (ticker, XLY) and the Consumer Staples SPDR (XLP) hit a new high last week. We had been concerned about this ratio since it had had failed to make a new high since March of 2014. Yes, that is a long time ago (relatively speaking) and the market has generally continued up during that time. But that is the nature, and challenge, with divergences. However, with last week’s new high in the XLY:XLP ratio, that is one red flag that can be taken down.

That said, it does not mean the market cannot form an initial top here that will be tested later coinciding with a divergence in the ratio. Furthermore, it is possible for the market to form a significant top without any divergence period. It’s just that,historically, it has given such warnings. So we can breathe a little easier with the recent development.

However, we did say we had bad news as well so perhaps investors’ breathing may still be somewhat labored. By charting the action in the actual prices of the discretionary and staples sectors, we observe a few things. First, despite the new high in the ratio between the two, the discretionary sector, as measured by the price of the XLY, has not achieved a new high since April. Secondly, a view of the action in the XLP last week gives us a clue as to why the ratio went to a new high. Consumer staples stocks got hammered. Thus, the new high in the XLY:XLP ratio was more a result of the negative performance in the staples than anything overly positive in the discretionary sector.

Further evidence of this lack of “overly positive” action from discretionary stocks can be seen in our 2nd chart. This one shows another ratio: that of the Rydex Unweighted Consumer Discretionary ETF (RCD) versus the weighted XLY. As the unweighted average places equal weighing on all of its constituents, it can be a good measure of the health of the overall sector. We like to see as many stocks as possible participating in a rally and, therefore, like to see unweighted averages or funds leading the way. This is not currently the case in the discretionary sector. In fact, the ratio between the unweighted RCD to the weighted XLY just hit a more than 2-year low.

This situation again suggests that the relative high versus the staples was less a result of positive action in the discretionary sector than it was very poor action in the staples. So do we side more with the 2nd “bad news” chart over the 1st “good news” one since we can attach that asterisk to it? Not necessarily. A year from now, or 10 years from now, we likely aren’t going to look at the new high in the ratio and dismiss it as a product of just poor action in the staples. It is what it is: a new high. And that has generally been a positive thing for the broad equity market.

So we have genuinely good news and bad news in the discretionary sector. Is this unusual? Perhaps the specific combination of the 2 developments is quite unique. However, the fact that there are both good and bad inputs to consider is not unusual. In fact, that is the case every single day when analyzing financial markets. The task as a market analyst or participant is to parse the data, good and bad, and form an opinion or strategy. It is also a good reminder to be selective in choosing one’s investment inputs. Know what is most important in guiding your position.

Our process is based on quantitative, objective models. Therefore, the interpretation (after many years in developing the models) is now minimal for us. If we had to side with either the “good” or the “bad” charts in today’s post, it may be to the bad side. However, that may be colored by other criteria that we track that has us less than optimistic about the longer-term prospects for stocks. Nevertheless, there is certainly fodder for both bulls and bears here -- as is always the case.

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“Happy & Sad” photo by Farrukh.

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