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Stocks Versus Total Return Bond Index

To determine which of the two asset classes (i.e., stocks vs. bonds) performed better, investors often use a ratio that divides the S&P 500 Index (SPX) by the Total Return Bond Index. Typically, when the ratio rises, it implies stocks are outperforming bonds. And when the ratio declines, it suggests bonds are outperforming stocks.

Since bonds are fixed-income securities, bond values are highly sensitive to the changes in the economy, inflation rate, and the overall interest rate trend. Stocks are equities and are influenced by a variety of factors, including earnings and growth expectations.

The SPX to Total Bonds Index is an important ratio that not only captures the performances between stocks and bonds but can also identify the extreme highs (too expensive) and extreme lows (too cheap).

In the past 100-years, the highest reading occurred during August 1929 at 2.45, or just before the start of the 1929-1932 Great Depression/stock market structural bear market decline. Since the 1929 peak, the ratio has failed to approach the prior extreme high. However, on two occasions, the stock versus bond ratio topped at the 1.46-1.47 level. For instance, in November 1968 (1.47), heading into the Nifty-Fifty bubble/Stagflation cycle of 1966-1982. And again, in May 2000 (1.46), leading to the Tech/Telecom bubble and the ensuing structural bear decline.

It is interesting to note just before the Oct 1987 Stock Market Crash, the stock/bond ratio peaked during July 1987 at 0.95. During May 2007, the ratio again peaked at 0.93 ahead of the global recession/financial crisis. Both occurrences were significantly below the previous peaks established in November 1968 high (1.47) and in May 2000 high (1.46).

With many market pundits suggesting the stock market has reached a speculative level and is extremely overpriced, the current SPX/Bond ratio is trading at 1.26 (August 2021). Although it has risen sharply from its March 2020 low (0.79), it appears it can still trend higher.

So, the question then becomes, will the ratio retest 1.46-1.47 or the extreme highs established during November 1968 and May 2000? Does this imply SPX can sustain another melt-up phase culminating in the elusive speculative bubble that so many have been forecasting?

It is also worth mentioning a chart of the S&P 500 Index (Red color line) versus Total Return Bond Index (Orange line) comparing the percentage change between SPX and the Total Return Bond Index. In the past 100-years, the chart shows SPX gaining +66,658% (as of August 2021) and the Total Return Bond Index gaining +50,149%. Adding dividends to SPX would lead to a completely different picture.

In the past century, the chart shows only one period, during 1997-2000, that SPX consistently surpassed the Total Return Bond Index. Since the early 2000s, bonds have outperformed stocks up until last year. From July to September 2020, SPX finally passed the Total Return Bond Index from a percentage change basis. Does this imply stocks have entered a long-term outperformance cycle versus bonds? Or is this suggesting stocks are now expensive to bonds?

Source: Courtesy of Federal Reserve Bank of St. Louis and

Source: Courtesy of Federal Reserve Bank of St. Louis and

Source: Courtesy of Federal Reserve Bank of St. Louis and

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