Chart Last Updated: November 25 2020
Category: Risk On/Off
One of the best ways to measure the risk on/off environment with respect to stocks is to look at the relationship between the ETF for the S&P 500 (SPY) and the ETF that tracks utility stocks (XLU).
This relationship is a good measures the market's appetite for risk because utilities are considered one of the safest and most conservative market sectors due to their higher dividend yields and lower exposure to economic cycles.
When market participants fear risk or desire safer positions, "Risk Off", utilities will outperform the general market. When investors are more bullish on stocks, utilities will underperform.
A great indicator to measure this relationship is the ratio of the SPY versus XLU. It is calculated by dividing the price of SPY by the price of XLU.
When the SPY vs. XLU ratio is rising, it is an indication that the SPY is out performing the XLU and this is considered a "Risk On" environment. Likewise, when the indicator is falling, the utilities sector (XLU) is outperforming the SPY, which often indicates periods of increased market volatility.
This indicator can be used as either a market timing or a portfolio balancing tool, by illuminating trends, degrees, and changes in investors appetite for risk.
How to Use this Indicator Layout:
Right Upper Chart - This is the ratio chart and has three outputs. The red line is the actual daily value of the ratio. For this analysis, the precise value of the ratio is not always important, rather we focus on how that value changes over time (trending up or trending down). The blue moving average represents a 6-month average of the ratio and the black line represent 4-week moving average of the ratio.
Left Chart - This is a daily chart of S&P 500 ETF (SPY) with a simple 50-day (blue), and 200-day (green) moving average.
Right Lower Chart - This is a daily chart of XLU with a simple 50-day (blue) and 200-day (green) moving average.
For a complete review of how to use basic price chart with moving averages please click here:
It is considered bullish for U.S. equities or "Risk On" when the daily value of the ratio (red line) is over the black 4-week moving average.
We use the same concept for longer term readings and confirmation of the shorter term reading by looking at the ratio relative to its 6-month moving average. Absolute levels of the indicator can be utilized as support or resistance levels as well classic chart readings techniques which include slope and the use of trend lines.