Chart of the Week - Stocks are turning the corner vs bonds
The US stock/bond ratio has rolled over from extraordinary price levels + excessive relative optimism in stocks vs bonds + extended positioning + extreme expensive valuations for stocks (both absolute and relative to bonds).
Meanwhile, the macro backdrop is about as unfavorable as it gets for the stock/bond ratio; heightened uncertainty, reform-like policy moves, and declining economic confidence makes the risk of recession a real possibility (and the Treasury Secretary is basically telling us this).
$S&P 500(.SPX)$ $SPDR S&P 500 ETF Trust(SPY)$ $iShares 20+ Year Treasury Bond ETF(TLT)$
The fiscal contraction aspect is also a double whammy in that it is a headwind for stocks and supportive for bonds through the possibility of short-term decline in growth/inflation, and improved sovereign credit quality from the prospect of a better fiscal position if DOGE is maximally successful.
Remember: the stock/bond ratio goes down when you get either-or-both of stocks falling and bond rising.
The stock/bond ratio was always going to be at risk of a sharp drop coming from a starting point of high valuations for stocks, high sentiment, and high portfolio allocations… especially given cheap valuations for bonds, low sentiment and low allocations to bonds (particularly following the bond shock and dismal returns in recent years — investors as a group tend to be highly focused on recent returns; momentum chasing/fleeing).
As things currently stand, there is a long way to go before we can get excited about stocks vs bonds from a valuation standpoint, and if anything you typically see downside overshoot during periods of mean reversion like this.
So from an asset allocation standpoint it sure seems prudent to rethink the stock/bond mix, particularly vs where portfolios might have drifted to in recent years as stocks significantly outperformed bonds. The key point really is to not be fixated on what used to work in recent years, because that (and the consensus industry positioning) is likely to be dangerous and suboptimal in the coming months and years.
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