The above charts represent price ratios between pairs of sector ETFs within the S&P 500 universe. Each represents a theme that I consider to be a driver of the recent bear market. Accordingly, I am watching these ratios (and themes) for indications of a continuation vs. reversal of bear market dynamics.
The first theme (top chart) represents the price ratio between the Materials ETF (NYSEARCA:XLB) and the Financials ETF (NYSEARCA:XLF). It depicts the relative valuation of physical assets--raw materials--to financial assets. In a weak dollar environment, as well as an environment of low confidence in the banking sector, raw materials should be more attractive than financials. A reversal of this ratio would suggest that the dynamics underpinning the weak dollar (expectations of further interest rate cuts by the Fed; lack of G-7 action toward a stronger dollar; recessionary expectations; fear of bank failures) were shifting.
The second theme (bottom chart) represents the price ratio between the Consumer Staples ETF (NYSEARCA:XLP) and the Consumer Discretionary ETF (NYSEARCA:XLY). It depicts the relative valuation of defensive stocks--those traditionally deemed relatively recession-proof--vs. those that are more vulnerable to contractions in consumer spending. In a recessionary environment, Staples should outperform Discretionaries as investors flee to sectors representing relative safety. A reversal of this ratio would suggest that the dynamics underpinning the recession (weak housing market; weak consumer confidence; weak employment market) were shifting.
What we see clearly in both charts is that, since mid-2007 (the period recently highlighted as one of changing intermarket dynamics), these ratios accelerated significantly as the stock market sold off. The XLB:XLF ratio topped out in mid-March (when the stock market made its price lows), pulled back sharply, and has since been clawing its way back toward its highs as stocks have fallen back. The XLP:XLY ratio topped out in early January (when the number of stocks making new 52-week lows maxed out), dropped back sharply, and has bounced back in a choppy manner since then.
Both of these ratios capture something of the psychology of the current stock market. A move to new highs would suggest that the psychological drivers of the recent bear market are intact. A failure to advance to new highs, even as the number of stocks registering fresh 52-week lows is dwindling, would have me questioning the bear's longevity.