A Look at the Stock / Bond Ratio
Hey, at least it's gone down a little, right?
Every day, we have to make a decision about where our money will be treated the best.
But the most basic allocation – stocks or bonds – is the one that gets the most attention and is surely the one most hotly debated. So today we're going to take a look at the Stock / Bond Ratio.
What is it?
The Stock / Bond Ratio is just that – a ratio of stocks to bonds. Both terms are pretty broad, so for this indicator what I use is a comparison of the S&P 500 exchange-traded fund, SPY, to the most available one for the bond market, the iShares Lehman 20+ Year Treas Bond, TLT.
The indicator is not a straight ratio between the two. Rather, it looks at the ratio's history over the past 90 days and determines how many standard deviations the current reading is from the average of the range.
Why should we follow it?
When one of these paper assets gets stretched too far in relation to the other – and I'm talking a true extreme here – then we tend to see mean reversion work its magic for a bit as big asset allocators like pension funds adjust their mix.
What are the challenges in using it?
The relationship between stocks and bonds is not static, as we've seen over the past 10 years. But on a shorter-term time frame, it does tend to be relatively consistent, especially when the two get really out of whack with each other.
On March 15, this indicator recorded a reading over 3.0. This means that the relationship between the two at that time was 3 standard deviations outside of the norm – an extremely rare event (the red and green arrows on the chart highlight 2 standard deviation events).
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