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Material Surge Relative to Discretionary Stocks

David Becker
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The Materials broke out to new highs in late February and then moved into a consolidation over the last two months. The XLB material XTF has formed a diamond pattern from early March to early May. The left half looks like a broadening formation, while the right half looks like a symmetrical triangle. The ETF is challenging the upper trend line now and a move above 48 would trigger a convincing breakout. Keep in mind that XLB recorded a 52-week high in early April and the long-term trend is up. A consolidation within an uptrend, therefore, is viewed as a bullish continuation pattern. On a relative basis materials are substantially outperforming riskier stocks such as discretionary stocks.

The consumer discretionary sector is the most economically sensitive sector in the stock market and the one investors should watch for clues on the economy. The Consumer Discretionary SPDR (XLY) in a long-term uptrend because it recorded a new high in early March. The ETF then fell back and tested the top of its big support zone in mid-April. Nothing much has been happening since mid April because XLY has simply consolidated.

When comparing the material to the discretionary stocks it is clear that the spread is moving higher and poised to test resistance near 0.80. This is the ratio of XLB divided by XLY and it moves higher as materials outperform discretionary stocks. During 2013 the XLY outperformed materials by nearly 16%, and that outperformance is being retraced during 2014. Momentum on the spread is also turning as the MACD (moving average convergence divergence) index is poised to generate a buy signal. Technicals can be used on spread in a similar way to the way they are used on outright stocks and ETF’s.

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