The consumer economy beckons generalizations, yet individual consumers make widely varying buying choices. That’s why, as Rodney shows above, you can simply compare the spending of a 20-something to that of a Baby Boomer and expect a congruent, apples-to-apples conclusion.

It’s also why, as we’ve long talked about, interest rates have less of an effect on consumer spending patterns than theoretical economics would suggest. The availability of cheap debt is not the only factor considered when we make buying decisions, despite what the Fed assumes.

Still, on a broad level, measuring relative activity in the consumer discretionary and consumer staples sectors typically gives a clue as to the future direction of the economy and the stock market.

Most recently, I highlighted weakness in the discretionary-to-staples ratio, which peaked in early October and has dawdled since. Here’s an updated chart of this ratio (in green), alongside the S&P 500 (in white).

See larger image

While the S&P 500 has gained 7% since October 4, making new all-time highs in the process, the discretionary-to-staples (XLY:XLP) ratio has failed to make new highs since peaking on October 4.

On the surface, that divergence should serve as a warning that weakness in stocks could be on the horizon. Yet, I did some number crunching and found something incongruent with the theory that suggests stocks are strongest when the ratio is making new highs.

Between January 25 and May 31 this year, the ratio was below its prior peak for about 80 trading days. During this time, the S&P 500 gained roughly 8.5%.

Then, from May 31 to October 4 the ratio was continually making new highs. Yet, the S&P 500’s return during that time was noticeably weaker, at 3.7%.

Finally, the ratio has been below its October 4 peak for the past 45 days. Again, the market returned a strong 7% during this time.

These observations imply the market is strongest when the XLY:XLP ratio is in drawdown, not while it’s making new-highs, as theory suggests.

Either way, I’ll be digging deeper into this consumer-specific data. I’ve recently recommended a bullish position in the consumer staples sector and I’m still expecting the sector do well over the next few months. Stay tuned for more research on this topic in the weeks ahead.

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Adam O'Dell
Adam O'Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with the minimum risk. Adam has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high profit potential. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. He is editor of our hugely successful trading service, Cycle 9 Alert.