Trouble Ahead

If there’s one indicator I watch with near religious devotion, it’s the stocks/bonds ratio.

This alone has proven a worthwhile warning mechanism of potential stock market corrections. I’ll explain the “why” shortly, but let’s start with some of the indicator’s recent successes.

Most recently, this indicator gave a warning signal on October 11, 2012. Four weeks later, the S&P 500 had dipped 6%.

Earlier in the year, on April 9, a warning signal foretold of the 8.4% correction that would last through June 4.

These dips were mild and tolerable, as most other indicators confirmed the stock market’s underlying strength. It was a different story in 2010 and 2011, when significant corrections tested the will of equity investors.

In 2011, this indicator gave prior warning of the year’s worst stock market drop. The warning sign came on May 13, 2011, giving equity investors time to get out before the market lost 18% going into early October.

One year earlier, this indicator flashed a warning on May 4, just before the stock market fell 13.5% through the beginning of July.

So without further ado, here’s the stock/bond ratio indicator… which has just recently turned bearish (red):

See larger image

Stocks and bonds tend to move in opposite directions during deflationary environments.

Declining inflation and interest rates signal a deflating economy, which is worrisome for stock investors looking for growth. Meanwhile, bonds become more attractive as interest rates look lower.

We’re at this tipping point right now.

This indicator does have the tendency to whipsaw…sometimes it gives false signals, where it turns red briefly, for a week or so, then turns green again. So waiting for confirmation from other indicators, rather than acting on Day 1, helps to avoid being shaken out of the market for no reason.

I don’t think this signal is a whipsaw, but it’s prudent to wait for a crystal-clear signal. When we see that, take note. This is NOT a signal you want to ignore. It has accurately forecasted most of the meaningful stock market corrections over the last four years.

There is definitely trouble ahead.

But stay tuned. We’ll have a clearer picture of what lies ahead within the next week or so. I’m watching this closely and will issue updates as the story unfolds.

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Categories: Markets

About Author

Adam O'Dell has one purpose in mind: to find and bring to subscribers investment opportunities that return the maximum profit with the minimum risk. Adam has worked as a Prop Trader for a spot Forex firm. While there, he learned the fundamentals of trading in the world’s largest market. He excelled at trading the volatile currency markets by seeking out low-risk entry points for trades with high profit potential. An MBA graduate and Affiliate Member of the Market Technicians Association, Adam is a lifelong student of the markets. He is editor of our hugely successful trading service, Cycle 9 Alert.