Today we’re talking about the best fundamental analyst on Wall Street.
Usually you won’t hear me talk too much about the funnymentals, but today that’s exactly what we’re focusing on.
First, let me set the stage.
According to the types of people who actually follow this stuff, consumer spending represents approximately 70% of the U.S. economy.
You’ve got the Consumer Discretionary stocks, where “Consumers” spend their “Discretionary” income – including retailers, automobiles, and home builders.
Then you’ve got the Consumer Staples stocks – consumers are going to buy these products regardless of how good or bad the economy might be – toilet paper, cigarettes, potato chips, toothpaste, booze.
When you compare one group of stocks to the other, you’re going to get a good idea about the general health of the market.
How Things Work
Mutual funds represent about $25 trillion of assets in the U.S. equities market.
That’s more than double the value of all the exchange-traded funds, or ETFs, right now, just to put in perspective how large the mutual fund market still is.
In a lot of cases, mutual fund managers have to be fully invested, by mandate – that means they can’t run to cash, or short stocks, or buy bitcoin or gold or any of those other things. They have to be almost fully invested in stocks at all times.
The way they get paid is to outperform the market. They don’t get paid to make investors money. More specifically, they’re incentivized to beat their benchmark, usually something like the S&P 500 Index.
The way they do this is by overweighting the Consumer Discretionary stocks during bull markets and healthy environments while underweighting more defensive Consumer Staples stocks.
During the bear markets, you’ll see a flight to safety into the Staples, particularly relative to the more offensive Discretionaries.
Equally Weighed Indexes
One way to view this ratio is to compare the Consumer Discretionary Select Sector SPDR Fund (XLY) and the Consumer Staples Select Sector SPDR Fund (XLP).
Each of the indexes these funds track are market-cap weighted, so the largest companies represent the biggest allocations in the index.
The thing is, Amazon.com (AMZN) represents 24% of the Discretionary Index, with Tesla (TSLA) alone bringing 15% more.
To get a broader and more balanced look at their relative performance, we can look at the equally weighted versions of each of these sector indexes.
This chart is commonly referred to as the “Best Fundamental Analyst on Wall Street”:
For my money, if this ratio is above those Global Financial Crisis highs from 2007 as well as the post-COVID peak in late 202, I find it difficult to be overly bearish.
This is a major secular breakout in this relative trend, and the path of least resistance is higher.
Come talk to me if this ratio is below all those former highs, and maybe we can have a different conversation.
But, based on all the information we have right now, this is not a trend we want to fight at all.
If that ratio is above all those former highs, we want to continue to put money to work into risk assets and to participate in this bull market.
People are bearish out there. And I think they’re wrong.
This chart confirms that.
And I’ll go with the chart over the humans any day of the week.
Stay sharp,
JC Parets, CMT
Founder, TrendLabs