Consumer Staples: The Sweet Spot Between Downside Protection & Upside Potential

Consumer Staples (XLP): The Sweet Spot Between Downside Protection and Upside Potential

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Key Points:

This Market Regime Newsletter was issued on March 24th, 2024

With stretched valuations and oversold conditions in certain markets, the defensive nature of Consumer Staples (XLP) – coupled with its high upside potential – presents a compelling case not only for latecomers.
Despite its defensive nature, our data provides robust evidence of a promising outlook, especially when compared to cyclical sectors.
This is supported by the sector’s recent transition into a ‘Very High Reward’ market regime for both short- and long-term perspectives, indicating a robust uptrend backed by high trend quality and increasing smart money positions.
Throughout history, the Consumer Staples (XLP) saw gains in 84.6% of instances during short-term ‘Very High Reward’ market regimes and in 70% of all cases during long-term ones.

Current Market Regime of Consumer Staples (XLP)

Description of the Current 'Very High Reward' Market Regime:

Highly positive market regime accompanied by significantly low volatility. Prices consistently show an upward trend, supported by a wide range of well-performing stocks within that market. Even in the face of negative news, the market demonstrates remarkable resilience with such a high positive trend quality. Weak trading days are typically short-lived overbought or sentiment driven reactions, leaving the market better positioned for further gains.

While the short-term trend condition signaled a ‘Very High Reward’ market regime as early as December last year, the long-term trend condition followed suit recently in mid-February.

Driving Forces Behind the Current Market Regime:

Our research categorized the market into six predefined market regimes based on trend strength and trend direction. In order to analyze these two forces, we utilize indicators covering essential performance factors such as trend, trend quality, sentiment, and the positions of smart and dumb money. These indicators are consolidated into Market Health Indicators, measuring signal positivity across different timeframes for unbiased trend analysis.

The chart below illustrates the Consumer Staples ETF (XLP) in the first panel, followed by three subsequent panels detailing Short-, Mid-, and Long-Term Market Health over time. Scores on a 0 to 100% scale denote signal positivity, with values below 50% are indicating a negative outlook and those above 50% signaling positive sentiment.

The Consumer Staples ETF is currently trading well below its latest high achieved in April 2022. Although it had shown a steady uptrend since Q4 2023, the momentum of this uptrend was relatively weak compared to other markets. For instance, the Nasdaq 100 rallied 30% since its low in October 2023, while the S&P 500 gained 27%. In contrast, the Consumer Staples ETF only saw a 14.3% increase during the same period. This discrepancy is not surprising, given that the uptrend in the Consumer Staples ETF was primarily supported only by increasing Short-Term Market Health, while Mid- to Long-Term Market Health exhibited only marginal improvements over time. Such a Market Health Combination normaly triggers a ‘Very High Reward’ market regime on a short-term basis, while still mainaining a ‘Very High Risk’ or just a ‘High Risk’ market regime on a long-term perspective.

Currently, all our Market Health Indicators remain strong, signaling a robust uptrend that is gaining momentum. Given the defensive nature of consumer staple stocks, the emerging of such a relatively young uptrend with increasing momentum appears highly compelling. This is not only attractive for latecomers but also for those looking to secure profits or seeking risk-adjusted returns. While temporary consolidation periods may occur, the risk of a major trend reversal remains low as long as Mid- to Long-Term Market Health maintains strong readings.

How to spot high-reward & low risk market opportunities

3 Steps for Determining Market Regimes

With our structured approach, we can identify the respective market regime for any market. Our methodology include the following steps:

1

Identify Robust Trends

Trends are measured through a systematic screening of signals from multiple indicators (for example the WSC Trend Index, the Smart Money Flow Index or the Daily Put-/Call Ratio All CBOE Options)
These indicators cover various categories (trend, trend quality, and sentiment, including dumb- and smart-money positioning) and timeframes.
This diversified approach minimizes the impact of noise in individual indicators and enables an unbiased and robust view of current market conditions.

2

Monitor Market Health

These indicators are representing composites of these signals for three different timeframes.
Scores on a 0 to 100% scale denote signal positivity.
Values below 50% indicate a negative outlook, while those above 50% signal positive market health.
The combination of these health indicators results in market regimes, indicating the strength of the current trend for a specific timeframe.

3

Determine Market Regimes

By combining short- to mid-term and mid-term to long-term market health readings, the specific market regime is determined.
These Market Regime gauges help identify market regimes and shifts without the hassle of going through all indicator signals.
To be more precise, the Tactical Short-Term Market Regime is constructed upon the combination of short- to mid-term market health, while the Strategic Long-Term Market Regime is based on the amalgamation of mid- to long-term market health.

In addition to identifying strong up- and down-trends, our Market Health Indicators also allow us to distinguish between healthy and corrective consolidation periods. This capability stands as our greatest advantage, given that consolidation phases represent pivotal moments. They can either serve as platforms for further gains or mark the onset of more significant downtrends. Consequently, deciding whether to capitalize on profits, capitalize on potential dips, exit the market, or even adopt a short position becomes challenging in such scenarios.

As shown above, healthy consolidation periods are usually characterized by short-term indicators turning negative, while the mid- to long-term condition remains robust. This pattern was evident from May to early July in 2023 and in early February 2024. In such situations, the market often trades sideways, pausing before resuming further gains. The situation differed slightly from August to early November 2023. There, Short-Term Market Health dropped below 50%, while Mid-Term Market Health also started to deteriorate, finally dropping below 50%. This serves as an early warning signal, indicating that the ongoing breather has the potential to evolve into a more significant correction. Indeed, the Consumer Staples ETF (XLP) initiated a stronger correction in September, with Market Health readings declining until late September, before rebounding back above 50%, indicating a forthcoming stronger recovery.

Currently, Short- to Long-Term Market Health Indicators are trading at robust levels across all time frames. This indicates persistent strength among numerous indicators such as MACD, RSI, stocks above 20/50/100/150/200-day moving averages, new highs vs. new lows, smart money positions, and other sentiment indicators such as call-put ratios and sentiment surveys. This reinforces our optimistic outlook – at least until mid- to long-term Market Health continues trading above 50%.

From Market Health Indicators To Market Regimes:

These positive Market Health Readings are also reflected in our Market Regimes Gauges below. By combining short- to mid-term and mid-term to long-term market health readings, the specific market regime is determined. These Market Regime gauges help identify market regimes and shifts without the hassle of going through all indicator signals. To be more precise, the Short-Term Market Regime is constructed upon the combination of short- to mid-term market health, while the Long-Term Market Regime is based on the amalgamation of mid- to long-term market health.

What the history tells us about the current Market Regimes

Since the availability of full market regime data dating back to 1998, the Consumer Staples ETF has entered a ‘Very High Reward’ market regime 370 times from a short-term- and 130 times from a long-term point of view. These market regimes are categorized by Short- To Long-Term Market Health readings above 50%.

Remarkably, in 84.6% of these instances, the Consumer Staples ETF (XLP) yielded a total cumulative gain of 538% for short-term traders and 236% for strategic long-term-oriented investors. The most substantial gain recorded within these occurrences was an impressive 16.7% for tactical investors and 21.5% for strategic ones.

The Bottom Line

Given the defensive nature of this sector, coupled with its current ‘Very High Reward’ market regime across both timeframes, the outlook for the Consumer Staples ETF (XLP) remains highly compelling.
This presents an attractive opportunity not only for latecomers but also for investors aiming to secure profits or just seeking attractive risk-adjusted returns.
While temporary consolidation periods may occur, the risk of a major trend reversal remains low as long as Mid- to Long-Term Market Health maintains its strong readings supporting a positive market regime.