Consumer Staples or Consumer Discretionary?

With the holiday shopping season here, Americans no doubt will be ringing up the cash registers as they embark on their annual holiday shopping spree.

Consumer Discretionary (XLY - News) companies such as Amazon(AMZN - News), Best Buy, and Starbucks will all see increased sales the next month, many even making a substantial amount of their yearly profits in the coming weeks.

But just because companies are going to earn significant amounts of dollars over the next month and their revenues will likely rise year over year does not necessarily mean they will be good investments.

Even more, how do you even choose between Ford Motor Company or McDonalds (MCD - News) or between the larger Consumer Staples (XLP - News)companies of Wal-Mart or Proctor and Gamble (PG - News)?

At some point valuation needs to be considered.

To Invest or Not to Invest, that is not the only Question More often than not the investment decision is not as straightforward as simply to just invest or not to invest. Once we decide to put money to work we also must then choose how and where.

This usually involves some technique such as ratio analysis or discounted cash flows, but often it can be as easy as looking at a chart.

Take a look at the chart below, which we provided to subscribers in our December Newsletter.

Comparing Apples to Apples The chart above shows the Consumer Staples Select Sector SPDR's (XLP - News) price divided by the Consumer Discretionary Select Sector SPDR's (XLY - News) price through time. Looking at the charts can sometimes help take the guesswork out of typical stock research, like what will earnings do, or how many televisions will Best Buy sell this holiday, and this chart is no different.

It shows us which sector has been bought up in price more than the other and therefore which sector is relatively cheap right now compared to its past price relationship with the other sector. It also shows us which sector is a better value right now.

Techniques that Work

Utilizing a similar relative strength technique and outlined in our article "The Two Month Vix Cycle" helped us capture an 84% gain back in May when we suggested in our Newsletter to buy VIX July $13 call options for $370. When the VIX (VXX - News) rallied into the upper teens we cashed out, and again we are watching another similar VIX setup today as the VIX falls back to cheap levels.

The above technique shows when deciding to invest in Discretionary (VCR - News) or Staples (VDC - News), the Staples are nearing their low point in valuation and thus their high point in value proposition.

Since the 90's and shown in the chart, the Consumer Staples sector has never cost less than 60% of the cost to own the comparable Discretionary ETF. At 67% today it sits near its historical lows compared to what it will cost you to buy a comparable share in the Discretionary ETF. This implies XLP should outperform going forward, just as it did from 2000-2001 and 2005-2009 with much less downside risk. In a similar scenario, XLP would outperform XLY by over 40% the next few years.

Put another way, Consumer Discretionary stocks are reaching their upper extremes of valuation, and are thus expensive when compared to Consumer Staples.

Long term investors deciding which sector to buy should choose Staples if they are looking for the better long term value.

The ETF Profit Strategy Newsletter utilizes technical analysis such as relative strength to help investors make high probability trades. We also provide weekly picks and a twice weekly Technical Forecast with a focus on the shorter term trends of all asset classes.

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