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Stocks Vs Bonds: Who's Lying?

Published 06/10/2016, 11:14 AM
Updated 07/09/2023, 06:31 AM

Common wisdom tells investors that bond prices drop when stocks go up and vice versa; also know as risk on vs risk off. This is for most of the time a true negatively correlated relationship. But, what happens when this correlation disappears? Lets take a look at the S&P 500, SPY (NYSE:SPY), and iShares 20+ Year Treasury Bond (NYSE:TLT) since TLT's inception in 2002; see figure below.


SPY:TLT Daily Chart

The blue line is the SPY:TLT ratio, reflecting the stock vs. bonds relationship. The black line is the S&P 500. The chart clearly shows for most of he time when the ratio goes up the S&P 500 goes up; and when the ratio goes down the S&P 500 goes down. Hence, our common wisdom is correct. But, there are a very exceptions; and those occured mid- to late-2007, early- to mid-2011 and throughout 2014. These are shown with the green and red lines. During those times the SPY:TLT ratio went down while the S&P 500 continued higher. In each case the S&P 500 was lying and had to correct or downright crash. The bonds were telling the truth: the smart money was already moving into bonds as the end-game neared.

Unfortunately, for the the stock market, we curently see another -now rather massive- divergence between the S&P 500 and the SPY:TLT ratio. The latter has been decreasing in a stair step fashion since mid-2015, while the S&P 500 has been range bound, oscillating between around SPX1800-2100, and it is currently only less than 2% below its May 2015 all time high. Hence, based on this 13+ year long relationship the odds tell us that the stock market is once again most likely lying and the SPX2121 high, which we correctly foretold 2 days ago (see here), may very well be a very significant high.

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