Staples And Materials: Which Sector To Hold And Which One To Fold?

The relationship between Staples and Materials

• Long-term relative trends
• Breakouts and breakdowns
• Which of the materials sub-components are breaking out?
• Euro looks short-term toppy

The relationship between Staples and Materials

Most of the time I concentrate on the trend of the overall market, but some sector charts for Consumer Staples and Materials crossed my desk over the weekend. I found them to be quite fascinating, since they depict two totally different technical situations.

By way of background, Staples are essentially a defensive sector, because they tend to pay good dividends and their relatively stable earnings path are easier to predict. Generally speaking, they tend to do well in the later stages of a bear market and the early phase of the bull, when rates are falling and investors are cautious.

Materials on the other hand, tend to do better during the more mature phase of the bull market, when conditions tighten and commodity prices are firm. Chart 1 compares the performance of two key ETF’s since the turn of the century. They are the SPDR Consumer Staples and the SPDR Materials, the XLP and the XLB. Both experienced strong bull markets between 2003 and 2008 and 2009 until the present.

Chart 1

Long-term relative trends

Chart 2 indicates, that between 2000 and 2008, Materials outperformed. However, between 2008 and the start of 2016 it was the turn of Staples to be stronger. Since the turn in 2016, Materials have risen sharply against Staples, to the extent that the ratio itself and its long-term KST recently violated a major down trend line. Read about the KST here. All this strongly suggests that Materials will continue to outperform using a 6-month to 2-year time horizon.

Chart 2

Breakouts and breakdowns

Charts 3 and 4 show both series together with their relative action against  the S&P Composite. Chart 3 features the XLP, where we can see that the price is resting on its 200-day MA and the 2013-17 up trend line. The bearish long-term KST, in the second panel, suggest that a violation will develop. However, it is the relative action that is most worrying, as the RS line has decisively broken down from its 2014-17 top and is now comfortably below its 200-day MA.

Chart 3

Chart 4 on the other hand, shows that the price of the XLB has experienced a marginal upside breakout, which is supported by a rising KST. Equally important is the upside breakout above the 2011-17 down trend line by the relative strength line. The relative breakdown by Staples and the relative breakout by Materials clearly confirms the idea that, given the choice between the two, Staples should be avoided and Materials embraced.

Chart 4

Having said that, Chart 5 shows the ratio between them on a shorter-term basis. We see the strong upside breakout favoring Materials, but post breakout price action has left several gaps on the charts. The horizontal blue arrows point up the fact that gaps, being emotional points on a chart, have a strong tendency to be filled. The problem, is that we never know ahead of time when that’s likely to happen, as that’s up to the market to decide. Since the KST in the bottom window is also at an extended reading it seems likely that Materials will need to digest some of their recent gains against Staples, as the gap below current prices is filled. However, once that corrective process has run its course the charts strongly suggest that Materials will out-perform, and that is the trend on which to focus.

Chart 5

Which materials are breaking out?

The Materials sector consists of nine industry groups. Charts 6-9 feature some of the stronger ones. Chart 6 displays Commodity Chemicals ($DJUSCC), where we can see solid breakouts on both an absolute and relative basis.

Chart 6

Specialty Chemicals ($DJUSCX) appear in Chart 7. Their breakout is slightly less impressive, but is nevertheless supported by both KSTs.

Chart 7

Aluminum ($DJUSAL) has started to breakout of an even more impressive base going back to late 2008. The absolute breakout is so far anemic, but the positive KST for the absolute price suggests that a more decisive one will follow.

Chart 8

Finally, Non-Ferrous Metals ($DJUSNF) is struggling to move above its two resistance trend lines. Once again, positive momentum argues for an eventual upside break.

Chart 9

Euro looks short-term toppy

Finally, Chart 10 indicates some short-term vulnerability in the Euro. Exhaustion began to show in late August with the appearance of a key reversal day. Later, in early September, the currency tried to cancel this effect but failed in its attempt at new highs. The price subsequently violated the April/September up trend line, which confirmed the effectiveness of the key reversal. Finally, this week, the price broke below the small horizontal red trend line, thereby completing a top. The bearish KST argues for more weakness or some extended ranging action in the weeks ahead. Bottom line, the bull move is likely over for a while.

Chart 10

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.