STOCK/BOND RATIO STILL FAVORS STOCKS BUT HAS GOTTEN OVERBOUGHT -- SO HAS THE VALUE/GROWTH RATIO -- AND THE TRANSPORTATION/UTILITY RATIO -- ALL OF WHICH SUGGESTS THAT THE RECENT SURGE INTO STOCKS AND OUT OF BONDS MAY BE GETTING OVERDONE
STOCK/BOND RATIO IS OVERBOUGHT... Several market messages over the past couple of months used relative strength ratios to paint a more bullish picture of the stock market, and a more bearish picture for bonds. While those ratios have strengthened considerably, especially since the election, I'm a little concerned that they're starting to look stretched. On October 28, I showed a ratio of the S&P 500 divided by the 20+year Treasury Bond ETF turning up in favor of bonds. That's the lower circle in Chart 1. Since then, the stock/bond ratio has soared to the highest level in nearly three years. That puts it up against a potential resistance barrier at its late 2013/early 2014 peak. In addition, its 14-day RSI (top of chart) has reached the 80 level which is the most overbought reading in years. More concerning is the fact that its 14-week RSI line has also reached overbought territory.
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Chart 1
STOCK/BOND RATIO OVERBOUGHT ON WEEKLY BASIS... For the study of major market trends, weekly indicators are usually more reliable than dailies. Chart 2 shows a "weekly" version of the same stock/bond ratio from Chart 1. The pattern of higher peaks and higher troughs since 2009 has generally favored stocks over bonds. That wasn't true, however, during 2011 when the stock/bond ratio dropped, or during 2014 and 2015. During those three years, bonds did better than stocks. The rising ratio during 2016 shows the pendulum swinging back to stocks, especially since the election. There are a number of points worth noting here. Over the longer run, the shape of the ratio appears to favor stocks over bonds. Over the shorter run, however, there is some concern. First, the ratio is nearing a previous peak from three years ago where it could meet some resistance. The second is the fact that the 14-week RSI line (top of chart) is in overbought territory over 70 for the first time since late 2013 (and early 2011). Both instances led to pullbacks in the ratio. All I'm suggesting here is that the stock/bond ratio appears very stretched. In other words, the steep move out of bonds into stocks may be getting overdone. That would suggest a bit more caution pushing the buy stock/sell bond strategy, especially as we enter the new year. We see the same pattern in several other ratios.
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Chart 2
VALUE VERSUS GROWTH RATIO IS ALSO OVERBOUGHT... My message from November 10 showed an upturn in favor of value stocks (mainly financials) over growth stocks (mainly technology). Chart 3 shows a ratio of the S&P 500 Value iShares (IVE) divided by the S&P 500 Growth iShares (IVW) completing a bullish breaking right after the November 8 election. The trend of the ratio is still upward. There again, however, the ratio has moved into overbought territory over 70. The 14-week RSI line has done the same. Which simply suggests that the ratio has risen too far, too fast and may stall for awhile. That may be another way of saying that the surge in financial stocks may also be overdone. That may also explain why large technology have shown better relative strength over the last couple of weeks.
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Chart 3
TRANSPORTATION/UTILITY RATIO IS ALSO STRETCHED... Another mid-November message showed the upturn in the transportation/utility ratio (Chart 4). That revealed that investors were rotating into economically-sensitive stocks (like transports) and out of bond proxies (like utilities). There again, the trend of the ratio is still upward. However, it has reached a potential resistance barrier along its late 2015 peak. And its daily and weekly RSI lines have reached overbought territory over 70. The 14-day RSI (top of chart) has already started to weaken. The message is Chart 4 is the same as in the others. The uptrend in the ratio is still intact and continues to favor transports over utilities. But it's gotten too stretched over the short-run and may stall for awhile.
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Chart 4
DOLLAR INDEX SURGES TO 14-YEAR HIGH ... One of the main beneficiaries of the Fed's plan to hike rates three times next year has been the U.S. Dollar. That shouldn't be a surprise because the U.S. is the only country that's starting to raise rates (intentially). [Some emerging markets are being forced to hike rates to defend their currencies]. Europe and Japan are still in an easing mode. Chart 5 shows the U.S. Dollar Index ($USD) surging yesterday to the highest level in 14 years. As usual, the rising dollar carries good news for some, and bad news for others. For one thing, it's a depressant on commodity prices, and precious metals in particular. In time, the rising dollar could start to weigh on the earnings of large cap U.S. multinationals whose foreign earnings may be hurt. The rising dollar, however, favors small cap stocks and companies whose earnings are more domestic. A rising dollar is especially dangerous for emerging markets which are starting to lag behind foreign developed markets. Weaker emerging currencies are usually a bad sign for EM bonds and stocks. The Chinese yuan has fallen to an eight-year low against the dollar while Chinese bond yields are surging. That's may hurt Chinese stocks. One final thing. The Euro has fallen to a 13-year low against the dollar and the Japanese yen has fallen sharply. That's usually good for their stock markets which are rising. As I recently explained on December 8, however, American investors looking to buy into those regions need to use a vehicle that hedges out the falling currency risk.
