I’m a medical school dropout.
And since I vowed not to waste that $40,000 I spent to realize that I actually didn’t want to be a doctor… I now find myself borrowing concepts from the medical profession and applying them to market analysis (my true passion).
Doctors routinely check patients’ levels of two types of cholesterol: “good cholesterol” and “bad cholesterol.”
Bad cholesterol clogs arteries and can lead to heart attacks and strokes. Meanwhile, good cholesterol works to clear bad cholesterol out of our blood.
So, to a doctor, the relative levels of good and bad cholesterol provide a useful gauge of a patient’s health. The doctor wants to see a high level of good cholesterol and a low level of bad cholesterol.
Said another way… a healthy patient’s blood should show a high ratio of good-to-bad cholesterol.
Much like doctors, market strategists are continually monitoring the “health” of bull markets… looking for potential warning signs that their “patient” is about to croak.
And one way to keep your finger on the market’s pulse is to measure investors’ willingness to buy into high-risk/high-return sectors.
Typically, when investors are confident and risk-seeking they prefer to buy stocks in the consumer discretionary sector more so than stocks in the consumer staples sector. And when investors are fearful and defensive, they prefer the relative safety of consumer staples stocks.
A simple ratio of these two sectors (discretionary-to-staples) acts as a useful gauge of investor sentiment. And when the ratio is falling, it indicates investors are growing increasingly wary and prefer a cautious and defensive stance.
It doesn’t mean a bull market is dead on arrival. But it’s a red flag that deserves close monitoring.
Since March of this year, the discretionary-to-staples ratio has trended downward, while the broad market continued to march upward. That’s a clear warning sign. Take a look…
Investors can still make good gains in “sick” markets… but you can’t be “all-out long.” And you have to know which sectors, specifically, are poised to outperform alongside the “risk-on/risk-off” sentiment du jour.
Go here to learn which sectors you should be in for the next two months.