XLP - a glance at relative performance

Sometimes to get a clearer picture of whats happening we have to look at relative performance. That is, one stock, ETF, Indices, etc vs another. The daily chart below is a relative performance (or ratio) chart of the XLP vs the SPY with an oscillator on the bottom portion. The quick look at this chart shows after underperforming the broad market for Q1 2012 by nearly 8%, consumer staples (XLP) has outperformed the broad market SPY in Q2 by approximately 4%. But more importantly the technical backdrop shows that recent outperformance waning and possibly setting up for a reversal.

2 factors lead me to believe XLP is close to a period (likely months) of underperformance vs the broad market...a breach of its 20day moving average and a crossing down from an extended level of the oscillator on the lower portion of the chart.

As you can see from the chart below in December 2011 this ratio crossed below its 20day moving average but it was at a time when the oscillator was just crossing up over the 0 line with upwards momentum in its favor. Mixed signals with no high probability setup. Not only until momentum was extended, did another fall below the moving average lead to a sustained decline. These 2 instances occurring together made the probability of a fall much greater. And at the risk of stating the blatantly obvious, a high probability trade is where we want to be.

Currently the setup is similar...the ratio is crossing below its 20day moving average with the oscillator crossing down from an even higher extension than that of late 2011. At this point the only thing that can negate the weak setup is a move over 0.26 which is the recent high as well as the highs from late 2011. Otherwise look for the ratio to fall (XLP underperforming vs SPY) back towards 0.245 or lower in the weeks/months ahead.

How to possibly profit from this development - rotate out of XLP/components (or get short exposure to XLP/components) and get long exposure in sectors that look poised to outperform or sustain their current outperformance. Experienced traders can put on a ratio spread where they buy one (SPY) and short the other (XLP) dollar neutral. If you don't know what that is and would like to know please ask.

Also, if you are interested in building such a ratio chart but don't know how to do so please comment or contact me and I will go through it with you.