• 308 days Will The ECB Continue To Hike Rates?
  • 308 days Forbes: Aramco Remains Largest Company In The Middle East
  • 310 days Caltech Scientists Succesfully Beam Back Solar Power From Space
  • 709 days Could Crypto Overtake Traditional Investment?
  • 714 days Americans Still Quitting Jobs At Record Pace
  • 716 days FinTech Startups Tapping VC Money for ‘Immigrant Banking’
  • 719 days Is The Dollar Too Strong?
  • 719 days Big Tech Disappoints Investors on Earnings Calls
  • 720 days Fear And Celebration On Twitter as Musk Takes The Reins
  • 722 days China Is Quietly Trying To Distance Itself From Russia
  • 722 days Tech and Internet Giants’ Earnings In Focus After Netflix’s Stinker
  • 726 days Crypto Investors Won Big In 2021
  • 727 days The ‘Metaverse’ Economy Could be Worth $13 Trillion By 2030
  • 727 days Food Prices Are Skyrocketing As Putin’s War Persists
  • 730 days Pentagon Resignations Illustrate Our ‘Commercial’ Defense Dilemma
  • 730 days US Banks Shrug off Nearly $15 Billion In Russian Write-Offs
  • 733 days Cannabis Stocks in Holding Pattern Despite Positive Momentum
  • 734 days Is Musk A Bastion Of Free Speech Or Will His Absolutist Stance Backfire?
  • 734 days Two ETFs That Could Hedge Against Extreme Market Volatility
  • 736 days Are NFTs About To Take Over Gaming?
  1. Home
  2. Markets
  3. Other

What Is A Key Ratio Saying About Stock Market Risk?

dice

If you knew (or thought) a bear market in stocks was just around the corner, would you prefer to be invested in 100% stocks or 100% bonds? Since the S&P 500 lost over 50% in the last two bear markets (2000-2002 and 2007-2009), the answer is easy. Therefore, we can learn something about the market's tolerance for risk by monitoring the ratio of stocks to bonds.


Dot-Com Yellow Flag

Since the aggregate bond ETF (AGG) was not trading in 1999, we will use the highly correlated Vanguard Total Bond Market Fund (VBMFX) for this exercise. The chart below shows the performance of the S&P 500 relative to a diversified basket of bonds. Since some investors became concerned about the sustainability of the dot-com bubble in late 1999, the demand for stocks started to wane relative to bonds, which was indicative of increasing concern about stocks and the economy (see slope of orange line below).

$SPX:VBMFX S&P 500 / Vanguard Tot Bond INDX/USMF


Financial Crisis Warning

The same "risk-on vs. risk-off" logic can be applied to the stock market peak in October 2007. The ratio peaked 5 months before the S&P 500 (compare slope of orange and green lines below).

$SPX:VBMFX S&P 500 / Vanguard Tot Bond INDX/USMF


How Does The Same Ratio Look Today?

Rather than waving "be careful with risk" flags in 2015, the same stock/bond ratio posted a new monthly closing high in February. The blue and red moving averages also look much healthier in 2015 than they did in the higher-risk stages of 2000 and 2007.

$SPX:VBMFX S&P 500 / Vanguard Tot Bond INDX/USMF


Investment Implications - The Weight Of The Evidence

Do the charts above provide an "all clear" signal for stocks? No - the present day stock/bond ratio simply tells us the probability of a new bear market kicking off in the next several weeks is quite a bit lower than it was in March 2000 or October 2007. Since the ratio studied here is not foolproof, our market model uses a wide array of inputs. A February 27 video covers the concepts above, as well as other risk measures, in more detail.

 

Back to homepage

Leave a comment

Leave a comment