S&P 500 Index Yellow Flag Confirmed
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Back in February of this year, I shared with you a chart divergence that had become a powerful market diagnostic tool for me. That article showcased the ratio spread of the Retail and Consumer Staples ETFs, XRT and XLP, as a noteworthy early divergent indicator for the broader-based market. That spread is once again diverging from the broader-based market, and is confirming for me the cautionary yellow flag that I previously suggested we watch for.
I recommend that readers review the original article before proceeding with this update (see A Key Spread to Watch: 02-28-2012).
The red arrows depicted in the chart below are referenced and explained in the February article. As you can see in this current chart, the same type of divergence that was present in 2007 is presenting itself again. The ratio spread, shown as a green bar chart, has since late March begun to move lower. That means that the retail sector as measured by the XRT has underperformed the staples sector as measured by the XLP.
The blue arrow to the right shows the descent of the ratio spread. On the other hand, the S&P 500 Index is shown as the black line chart. Notice that although it also faltered and began moving lower in late March from the year's high, it rebounded in late May and is currently retesting that high (shown by the green arrow); and that confirms the divergence. That is, similarly to 2007, retail has begun to underperform staples on a relative basis, while the S&P 500 Index continues higher. When this happened back in 2007, the S&P 500 Index eventually succumbed to a sell-off.
Please note that I am not suggesting that this means the broader-based market will experience a similar sell-off in magnitude to the 2007-2008 break, although that certainly could happen. Nor am I guaranteeing that the market sells off at all. Instead, I point out a divergence that previously was an early warning indicator, and suggest that if the previous trend is still intact, this divergence could be waving an early cautionary yellow flag for the broader-based market.
Chief Investment Strategist
Preferred Planning Concepts
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