Signals From the Stock/Bond Ratio

It is by no means a perfect indicator, but it certainly would have kept you out of stocks in the late 19th century debacle and the 1929-32 bear market.

By the same token, when stocks were outperforming bonds in the great bull runs in the 1930s, '40s and '50s, the KST would have indicated the favorable environment for equities.

Although the post-1950 period has not seen such volatility, this technique would still have caught most major advances and declines.

Right now, the KST is rising and is at a relatively overbought reading. This monthly series is not showing any signs of peaking, but when we look at its more sensitive weekly counterpart in Chart 3, a different story emerges.

At last Friday's close, it was teetering on the brink of a major sell signal.

Perhaps equally as important, the ratio recently broke above the (dashed) neckline of an inverse head-and-shoulders, but was unable to hold the breakout. It is now in danger of cracking below its bull market trend line. If the line is violated, the break would not only be bearish in its own right, but also would confirm beyond a reasonable doubt that the recent upside breakout was indeed a false one. Because whipsaw signals of this nature are typically followed by above-average moves in the opposite direction to that signaled by the breakout, a nasty decline in the ratio would be indicated.

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Source: Pring.com

The penetration of the trend line would also act as a domino by tipping the technical balance in favor of a long-term KST sell signal (for stocks against bonds). Remember, this is a relative relationship, and a downside break would only warn that bonds would likely outperform stocks.

However, in view of the recent false upside breakout, I would wager that the implied sharp decline in the ratio would be caused more by a weak stock market than a strong bond performance. The number to watch for in this regard is a weekly close below the line, say at 14.5. It is calculated by dividing the S&P Composite by the TLT.

Remember, the proven trend for this relationship favors stocks until the line is violated, so it would be wrong to anticipate a negative break before it happens. However, if the break does materialize, it would be a strong signal that bonds and bond equivalents, such as utilities and preferreds, are the assets of choice. It would not indicate that stocks are headed lower because this is a relative relationship. However, on most occasions when the ratio declines, it does so because equities are weak.

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At the time of publication, Pring had no positions in any of the stocks mentioned in this column, although holdings can change at any time.

Martin J. Pring is president of pring.com, and is actively involved in Pring Turner Capital Group, a money management firm. He also publishes the monthly market letter "Intermarket Review." Pring is the author of several books, including Technical Analysis Explained, and numerous educational, interactive CDs. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Pring appreciates your feedback; click here to send him an email.

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