Assessing the health of the U.S. consumer … how John Jagerson and Wade Hansen are analyzing market strength … which sector earnings are most important to the broad market today

Traders are always looking for clues about where the market is headed next.

Fortunately, we have two expert traders here in at InvestorPlace with an arsenal of helpful, powerful indicators.

Today, we turn to our technical experts, John Jagerson and Wade Hansen, of Strategic Trader.  The indicator they’re going to walk us through is a great way to check in on the health of the U.S. consumer.

As we noted in the Digest last week, a strong U.S. shopper is critical to avoid a recession. That’s because consumer spending makes up about 70% of the U.S. GDP.

So, what is this indicator revealing today?

Let’s find out.

***Clues about market direction from sector rotation

In their newsletter, Strategic Trader, John and Wade combine fundamental and technical analysis, along with historical market data, to trade options whether the market is up, down, or sideways.

Let’s pick up with them explaining the indicator that’s going to give us some idea about market direction today:

One method analysts and traders like to use to evaluate trader sentiment is intra-market analysis. That’s where you look at the individual sectors within the stock market to see which ones are outperforming and which ones are underperforming.

When sectors like financial and technology are outperforming, it usually means traders are bullish and the S&P 500 is likely to move higher.

Conversely, when sectors like utilities and healthcare are outperforming, it typically means traders are bearish or nervous, and the S&P 500 is likely to consolidate sideways or move lower.

John and Wade note that, unfortunately, this type of intra-market analysis takes a tremendous amount of work. Plus, interpreting the results often involves lots of nuance.

So, they looked for a way to simplify it. This led them to narrow their analysis to the two sectors that focus on consumers: Consumer Discretionary and Consumer Staples.

“Consumer Discretionary” represents companies like Amazon and Home Depot. These companies do better when consumers have extra money to spend and feel confident that their financial future will continue to be strong.

“Consumer Staples” represents companies like Procter & Gamble and Walmart. These companies tend to do well even during economic slowdowns. That’s because people still need to buy basic items to live (shampoo, toothpaste) despite a souring economy.

Back to John and Wade for why this comparison can be insightful:

Consumer spending accounts for approximately 70% of U.S. gross domestic product (GDP), so why not focus on the largest driver of the U.S. economy?

When consumers are confident in the economy, they tend to spend more on discretionary items, like a new pair of shoes or a new car.

On the flip side, when consumers are uncertain about the economy, they tend to pull back on their discretionary spending, and only spend money on the staples for day-to-day living, like shampoo and toilet paper.

***How to analyze consumer spending, and what it’s telling us today

John and Wade find that the easiest way to analyze the performance of these two consumer-related sectors is to create a relative-strength comparison chart.

Specifically, they’re comparing the Consumer Discretionary Select Sector SPDR ETF (XLY) and the Consumer Staples Select Sector SPDR ETF (XLP), and asking the question “which of these ETFs is doing better?”

When the XLY/XLP relative-strength chart is moving higher, it indicates XLY (Consumer Discretionary) is outperforming XLP (Consumer Staples). A downward move indicates the opposite – XLY is underperforming XLP.

John and Wade note that when the chart is in an uptrend, or is bouncing up off support, it signals the S&P 500 is likely to be supported by bullish pressure.

Conversely, when the chart is in a downtrend, or is bouncing down off resistance, it signals the S&P 500 is likely to encounter more bearish pressure.

So, what does this comparison chart tell us today?

From John and Wade:

As you can see in the XLY/XLP relative-strength chart Fig. 2, XLY has been dramatically underperforming XLP since mid-November when the world first started hearing about the Omicron variant of the coronavirus.

Source: TradingView

XLY started to recover and outperform XLP in early March as the Federal Open Market Committee (FOMC) became increasingly hawkish and promised to aggressively attack inflation and traders started pushing money back into Domestic Equity funds.

However, during the past two weeks, XLY has started to underperform again. The chart has been consolidating as XLP has been regaining strength.

This indicates increased bearish pressure is once again being applied to the S&P 500.

***Is this all because of interest rates?

John and Wade point out that many investors are blaming this bearishness on rising interest rates.

But they believe that narrative is too simplistic:

As you can see in the comparison of the XLY/XLP relative strength chart (black line) and the 10-year Treasury Yield (TNX) chart (candlestick) in Fig. 3, XLY was underperforming XLP while the TNX was climbing in late 2021 early 2022.

Source: TradingView

However, XLY started to outperform XLP in March when the TNX rocketed higher to 2.5%. This is certainly breaking with the narrative that rising interest rates have to drive the underperformance of XLY.

Of course, the underperformance of XLY resumed with the latest increase in the TNX during April.

So, what are we to make of these inconsistencies?

We think it all comes down to Wall Street’s confidence in the Fed.

The issue that John and Wade point toward is Wall Street’s fear that the Fed is going to be heavy-handed as it fights inflation, inadvertently killing off economic growth.

This fear is understandable when you listen to some of the recent Fed presidents.

For example, last week, Federal Reserve Bank of St. Louis President James Bullard called it a “fantasy” to think the U.S. central bank can bring inflation down sufficiently without raising interest rates to a level where they constrain the economy.

***What John and Wade are monitoring looking forward

This Q1 earnings season we’ve just begun will be the driving factor for the direction of the XLY/XLP comparison chart.

Back to John and Wade with what to watch for:

As long as companies are able to continue showing strong earnings growth, we think XLY will be able to hold its own against XLP, even as interest rates are rising.

If earnings season is a bust and companies report stagnating earnings, we expect XLY to continue its longer-term trend of underperformance.

If we look big picture, John and Wade expect that the broad market will get its direction based on the performance of big tech companies and consumer discretionary companies.

Here’s more:

If those earnings look strong, or we see more share buyback or stock-split announcements, we wouldn’t be surprised to see the SPX hold at support and potentially form an inverted head-and-shoulders pattern (see Fig. 4).

Source: TradingView

Figure 4 – Daily Chart of the S&P 500 (SPX)

Keep an eye on potential support at 4,360.

As I write Monday morning, the S&P is at 4,404, so 1% higher.

We’ll keep you updated.

***Before we sign off, a quick congratulations to Strategic Trader subscribers

So far in 2022, our Strategic Trader team has closed out 37 trades.

Of those 37, not a single one has registered a loss.

Here are John and Wade with a few more details:

Our average gain per trade is a nice 3.98%, and our average annualized gain per trade is 170.60%. 

Congrats on another fantastic week!

During this period of heightened market volatility and historic inflation, having a steady stream of profitable, income-boosting trades can make a big difference in your financial breathing room.

If you’d like to learn more about how John and Wade do it, just click here. In any case, a big congrats to all the Strategic Trader subscribers out there.

Have a good evening,

Jeff Remsburg