Take Two ETFs And Call Me …

A couple of weeks ago, we fretted about a possible stampede from equities because of an unnerving air of complacency. As it turned out, that trepidation was prescient. Four days later, on February 2, stocks tumbled into a crevasse.

So, what happened? And, more important, what’s likely to happen going forward?

Plainly, there were a lot of folks short volatility and, when the tide turned on fears of rising interest rates and inflation, a LOT of unwinding was forced by margin calls. These were trades made by pros—not your average Joe or Jane. Joe and Jane weren’t fazed by the market’s plunge. Not at first anyway.

How do we know this? The exchange-traded fund market tells us so.

First of all, there was the price spread between the S&P 500 SPDR ETF (NYSE Arca: SPY) and the iShares S&P 100 ETF (NYSE Arca: OEF). OEF is made up of the 100 bluest S&P 500 blue chip stocks, mostly mega-caps. Exuberance for equities is reflected in the two ETFs’ price differential. The broader-based SPY’s price appreciation is more expansive in bull markets,  widening the spread. Caution or downright fear is characterized by a narrowing spread.

In the chart below, you can see the recent topping in the spread. How recent? Well, a peak was actually reached on January 26, with the first daily 1 percent break occurring two trading days later. That was the warning bell since there hadn’t been a 1 percent slip since August 2017.

Elsewhere, there was still bullish exuberance. We’ve talked about ETF indicators of market enthusiasm the past. Back in January, for example, we examined the upside potential in the XLY/XLP ratio, a measure of consumer and investor confidence.

The ratio is the price quotient of the Consumer Discretionary Select Sector SPDR ETF (NYSE Arca: XLY) over the Consumer Staples Select Sector SPDR ETF (NYSE: XLP). XLP is made up of providers of the stuff you “gotta” have—toothpaste, groceries and the like. XLY constituents offer goods and services you “wanna” have. When punters feel flush, XLY outperforms XLP and the ratio rises. In bad times, the ratio sinks as investors and consumers become defensive.