The ratio between the Shiller P/E and Moody’s AAA Corporate Bond Yield compares the rate of return between stocks and bonds. It serves as a useful measure that reflects investor sentiment between the two asset classes. A low reading indicates that stocks are undervalued against bonds and a high one an overvalued and risky situation for equities. Usually when the ratio reverses from an undervalued level it represents a great buying opportunity for equities. Since 1880 four such situations developed. Three of them, 1921, 1932 and 1982 represented secular lows. By the same token, eight prescient sell signals were also triggered as the indicator peaked at or above its overvalued zone. Two of those warnings were also associated with secular peaks, namely those in 1929 and 2000.  Note that each of these signals was confirmed by a peak in the primary trend momentum for the ratio, plotted in the bottom panel. Historically, the bear trend has remained in force as long as this momentum series continued to decline.

Inflation adjusted equities versus the Shiller/P/E/ AAA Corporate Bond yield ratio
 

A ninth sell signal was triggered a few months ago and is warning that a new down leg in the secular bear market is probably underway.  This is, of course, only one piece of the puzzle that indicates a primary bear trend. Conclusive evidence would require some confirmation that prices were responding in a negative way.  In this respect, an event such as the S&P crossing below its 9-month MA would probably do the trick. That average will be around 1730 at the end of February.  It’s important to note that even though we believe the current secular trend to be negative the next primary bear market low may well bottom above that of 2009. In any event, the deterioration in this stock/bond return relationship does suggest that it’s not a bad time to take some chips off the table.

Martin is the Investment Strategist to the AdvisorShares Pring Turner Business Cycle ETF (DBIZ)—and since 1984, he has published the “Intermarket Review,” a monthly global market report revered among analysts and market technicians. Martin shares his technical analysis on the current stock/bond return relationship and its potential impact for the markets.

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