A handful of patience is worth more than a bushel of brains.
Because I continue to post bullish setup for stocks, some may think have thrown in the towel and have given up on my watch for a bear market. The fact is that couldn’t be farther from the truth. It’s just that until the weight of the evidence says otherwise, the trend is your friend and you must respect the current trend, which is up. I have learned the hard way picking tops or bottoms is a fool’s game. What is not foolish is having a proven investment process/plan and sticking to it. That said, in no way have I abandoned my vigilant watch to protect my client’s hard earned capital from the ravages of a bear market. The beat goes on, I have just tried to dampen the bearish overtones.
When looking for clues we are reversing course, one of my default charts I find not only very helpful but historically significant is what I refer to as “risk on/risk off”. It is the ratio of US stocks to US bonds, specifically the SP500 to the 30-year Treasury bond. While you may be scratching your head wondering why this is worth watching it actually does make sense. In a bear market, money flows out of stocks due to their risk component and into the safety net of bonds, especially US government bonds. In bull markets, investors are willing to risk their investment capital in stocks due to the chance of making greater returns. So if this ratio is rising, you would expect a bull market in stocks and of course, the opposite when the ratio is falling.
Below is a 20-year look back on “risk on/risk off” in the upper pane of the chart. The lower pane shows just the price of the SP500 index. Having them stacked on top of each other it allows you to follow how stocks move in comparison to the ratio. What is hopefully very obvious is how the ratio acted during the prior 2 major market corrections of 2000 and 2008. During each of those stock market peaks, the ratio high exceeded 14, bearish divergence (ratio was falling while SP500 price was rising) was evident and a nice topping pattern was formed as the ratio rolled over (changed direction from one of rising to falling). Fast forward to a look at the ratio today you see the EXACT SAME SETUP. The key going forward is if this is truly a market reversal and it picks up steam as it did in the past two occasions, once the horizontal red support line is breached, stock prices could be in for a major beating. While I want very much to pull the plug in anticipation of this occurring, I am going to find some patience somewhere and insure I get confirmation before jumping the gun. So far this correction has only been 5% and exiting all long equities positions over a 5% correction makes no sense. Normally a 5% correction would be considered a very normal ebb and flow within the context of price movement. In fact, I would consider it just noise.
Excuse the brevity of this post but I need to spend some serious time looking for that patience (where o where did I put it?). If this correction picks up steam I will present some other indicators in future posts I use to compile the “weight of the evidence” providing me “the” confirmation signal to step aside. Until then, we need to accept that corrections are a major part all bull markets and respect the fact the current market is bullish.