The outsized move in stocks (up) and bonds (down) over the past 2-3 weeks has pushed a number of indicators into extreme territory. The one most directly influenced by the interplay between the two markets is the stock/bond ratio. Less than a month ago, it was at 0, meaning the two markets were evenly “balanced.” In just the past week, it has gone from 1.5 to 3.
That latter number, 3, is for all practical purposes the maximum. Theoretically, there is no upper bound to the ratio, but in the 50-year history of this indicator, it has exceeded 3 for only a handful of days. Most of these extremes lasted between 1-3 months before we saw a correction.
In 1985 for example, the S&P managed to keep rising for another month after the Stock/Bond Ratio hit 3, but then corrected during the next three months, giving back most of those gains.
In 2006, stocks just keep rising…and rising…and rising, finally topping out about four months later. But in a matter of a few days in February and March 2007, all of those four months’ of gains were wiped out.
In 1991, stocks didn’t correct right away. The S&P rose for another few days, then started a very choppy two months where it added a bit more. Then it went into a seven-month stasis where it basically went nowhere.
The other 6 instances all led to a consolidation or correction soon after the Stock / Bond Ratio reached this level of extreme. – SentimenTrader
As with most things in life, the further something exceeds its average the greater the probability it reverts back to its average. Keep in mind a reversion can be accomplished either through a correction or a long period of consolidation where prices don’t change much thereby letting the average “catch up” to the current level. So the bottom line is while this is something I am watching closely, it no way implies a correction is imminent (especially in the very near term as the underlying market is showing incredible strength).