Stock/Bond Ratio Projects Exciting Times Ahead

Are stocks ripe for a deeper correction or is the 5%+ January hiccup – the biggest in well over a year – already in the rearview mirror? The stock/bond ratio provides a dimension not often considered.

The S&P 500 (SNP: ^GSPC) just had its first 5%+ correction in well over a year.

Some say that’s bullish, because it brought prices down to levels that spark new buying. Others point to a potentially bearish technical breakdown at a time when stocks are over-loved, over-valued, and over-hyped.

Which one is true?

As the old saying goes, there are always three sides to an argument: His, hers and the truth.

The stock/bond ratio provides another dimension to this ‘argument.’

We use the SPDR S&P 500 ETF (NYSEArca: SPY) as proxy for stocks and the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) as proxy for bonds.

The S&P 500 ETF – SPY/IEF ratio chart below shows the SPY/IEF ratio vacillating between support and resistance.

The SPY/IEF ratio rises when the S&P 500 moves higher and bonds move lower.

A spike in the SPY/IEF ratio accompanied every S&P 500 high. This includes the most recent January high.

However, the SPY/IEF ratio did not touch resistance at the most recent high. It also didn’t touch support at the most recent low.

Nothing says that resistance or support need to be met, but often such support/resistance levels act as magnets.

If the SPY/IEF ratio is still in need of touching both support and resistance levels, as a result, we conclude that the January high didn’t mark a major top and last week’s low didn’t mark the end of this correction.

Obviously, this would translate into exciting times ahead.

A detailed forecast for the S&P 500 is provided here:

S&P 500 Forecast: Short-Term Gains vs Long-Term Pain

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

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S&P 500/Bond Ratio Shows Stocks are Overvalued

Much has been written about the ‘great rotation’ from bonds into stocks. In reality, investors ask themselves every day if there’s more value in stocks or bonds. There’s one accurate measure to determine where’s more value.

Stocks or bonds? Essentially that’s a decision investors make every day.

As with pretty much every other purchase, investors want to get the biggest bang for their buck and avoid risk. In other words, risk/reward is key.

What’s the better risk/reward play right now? Stocks or bonds?

To find out we will take a look at the value of the S&P 500 Index relative to 10-year Treasury prices. The iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) is used as proxy for 10-year Treasuries.

The chart below plots the S&P 500 Index against a ratio attained by dividing the S&P 500 against the price of IEF (S&P 500:IEF).

This is one of the easiest and most effective ways to determine the value of both asset classes relative to each other.

The chart shows that S&P 500:IEF ratio extremes put the kibosh on stocks every time. The degree of the correction varied, but the direction for the S&P 500 was the same every time – down.

There is one problem though.

It usually takes hindsight to determine what constitutes an S&P 500:IEF ratio extreme.

The ratio, although extreme right now, could become more stretched. Will it?

The dashed horizontal gray line shows today’s ratio in correlation to prior readings. In fact, the ratio is at a point where it turned down in early 2007 and early 2008. This appears as natural resistance for the ratio … and the S&P 500.

The S&P 500:IEF ratio suggests that risk is increasing for the S&P 500.

This harmonizes with the S&P 500 chart, which conveys the message that stocks are at a short-term inflection point. This article highlights some technical ‘speed bumps’ most investors aren’t aware of: What’s Next For the S&P 500?