What Two ETFs Can Tell About the State of the Market

08/03/2010 12:01 am EST

Focus: ETFS

Corey Rosenbloom

Founder and President, Afraid to Trade

What can the Consumer Discretionary ETF (XLY) and Consumer Staples ETF (XLP) tell us about the current state of the market?

For one, they can clue us in to whether investors are seeking risk—by a strong move in the XLY Consumer Discretionary (Retail) fund—or seeking to avoid risk and be defensive—by a strong move in the XLP Consumer Staples fund.

Let’s start with a glance at the XLY daily chart:

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At first glance, we see that price broke above a declining trend line connecting prior highs to the April high—that’s bullish.

We also see price supporting currently both on the upside of the trend line and the 200-day SMA, currently at $30.75.  That’s also bullish.

As long as XLY stays above $30.50, it will bode well for the market.

In terms of volume, it has actually been trailing lower in July during the recent rally. That’s a non-confirmation that suggests that investors are not rushing to gain exposure to the discretionary sector right now.

Let’s keep that thought in mind and compare the chart to the consumer staples fund, XLP:

Click to Enlarge

Let’s start with volume before looking at the chart; and volume is clearly surging. During July’s rally in the market, we saw strong volume steadily rise in the consumer staples fund.

This indicates that investors may be playing defensively, or seeking shelter by the comparatively stable price moves of the companies in the staples fund—companies that sell things like toothpaste, food, cleaning supplies, and essentially, goods that consumers must buy during economic booms and busts.

Also, the chart position of XLP is stronger than XLY. Namely, XLP is down 4% (at time of writing) from the April high while XLY is down 12.5% from the high.

We see the same breakout above the declining trend line and respective support on the 200-day SMA, this time at the $26.60 price level. The 20- and 50-day EMAs also converge at a potential support zone at $26.60.

What’s the Takeaway?

In terms of volume, relative volume rose in the staples fund, while relative volume fell in July for the discretionary fund. That implies that investors are seeking safety rather than seeking risk and are more likely to play defensively.

However, both price charts of XLY and XLP—along with that of the S&P 500—reveal that price has key support underneath them, and as long as that support holds, it’s bullish as price broke above a falling key trend line.

That’s a bit of a contradiction, so continue watching these price charts closely, most importantly, in terms of their respective support areas:  XLY at $30.50 and XLP at $26.60.

This market teaches us that only price matters—and that many investors are quite bearish on this market.

Another thing to watch going forward is a respective break to a higher high to shift the charts more bullish, which would be a break above $33.00 in XLY while the XLP has already made that higher high. Look for a higher high above $27.50 to be quite bullish for XLP.

By Corey Rosenbloom, trader and blogger, AfraidToTrade.com
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