Stocks are up and so are bonds. That’s unusual because the ‘risk on’ and ‘risk off’ trade usually alternate not coexist. There’s a battle going on and the featured chart shows who’s winning the tug of war between fear and confidence.
To some degree investing is always a battle between confidence and fear. Confident investors buy stocks, fearful investors buy bonds.
As of late, schizophrenia seems to have entered the investment world. Investors are buying both bonds and stocks. What does that mean?
The first chart shows that stocks and bonds have been moving higher in tandem. We use the SPDR S&P 500 ETF (SPY) as proxy for stocks and the iShares Barclays 7-10 Year Treasury ETF (IEF) as proxy for bonds.
The kind of ‘hand-in-hand’ performance is unusual for two inversely related asset classes. To break the fear/confidence tie, it may help to take a look at the performance of stocks relative to bonds – the SPY:IEF ratio.
When the ratio is rising, stocks are in higher demand relative to bonds and when the ratio is falling bonds are in higher demand relative to stocks.
The second chart plots SPY against the SPY:IEF ratio (SPY divided by IEF). Here are the three key points:
- The SPY:IEF ratio has struggled to overcome resistance, but today shows an intraday bullish breakout.
- Some caution is warranted as previous SPY:IEF readings around 1.45 appeared near price highs for stocks.
Using the SPY:IEF ratio as a barometer for stocks we can draw the following conclusions:
- If today’s bullish breakout holds, the SPY:IEF ratio points towards higher prices
- The ratio is in danger territory. Stop-loss levels should be used to manage the increasing risk of long positions
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