An 'icy' ending: A Wall Street expert sees a critical market metric stretched to 'extreme' levels — and warns of a painful reckoning to come

  • Doug Ramsey, the chief investment officer at Leuthold Group, sounds the alarm on a crucial correlation he sees bringing an “icy” end to a portion of the market that’s been on fire recently.
  • Over the past 18 years, his go-to indicator has identified eight of the nine best times to sell US Treasury bonds.
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Separating the wheat from the chaff is one of the hardest things to do as a market participant.

With so many indicators, pundits, and exogenous factors simultaneously attacking investor psyches, it’s fairly easy to get caught up in the rigmarole. But being able to see the forest for the trees and focusing on what’s most important is crucial to successful money-managing — yet many investors struggle to do so.

But not all are prone to the pressure and distractions that come hand-in-hand with portfolio allocations, however — and they’ve identified a crucial correlation to help guide their next decision.

Doug Ramsey, the chief investment officer atLeuthold Group, thinks the time to strike is while the iron is hot — and right now, it’s glowing red.

He relies on a correlation that has identified eight of the past nine best times to sellUS Treasury bonds over the past 18 years.

In essence, Ramsey monitors the trailing 52-week correlation between weekly percentage changes in theS&P 500 and the10-year Treasury yield. Based on historical precedence, when these two metrics cross a certain threshold, it’s time for fixed-income investors to get the heck out of Dodge.

And wouldn’t you know it, that level has been breached asboth stocks and bonds have rallied in seemingly unabated fashion, defying the age-old idea that they should trade inversely.

“The relationship made a recent peak about the 0.40 level — the threshold we’ve arbitrarily considered to be extreme, and prone for reversal,” Ramsey said. “The simple rule we’ve developed is to wait for the correlation to drop by 0.10, once it has exceeded the 0.40 threshold, confirming that an interim peak in the correlation has been formed.”

The graph below depicts the relationship between S&P 500 weekly percentage changes, juxtaposed against the weekly percentage change in the 10-year yield.

Leuthold

Ramsey continued: “Definitive peaks in the stock/bond correlation have been excellent SELL signals on bonds, with the three-month horizon looking especially risky.”

Going back to 2003, yields have risen by an average of 45 basis points in the 13 weeks following signal. A stark warning for those with portfolios heavily skewed toward debt. Remember, when yields rise, prices fall.

The reading needs to drop by another 5 basis points for the top to be definitive. But at this rate, we’ll be there in no time.

The chart below shows how 10-year yields have fared after crossing Ramsey’s threshold four weeks, 13 weeks, 26 weeks, and one year later. All point to a substantial increase.

Leuthold

Though Ramsey’s indicator is a solid predictor of bond market action, the relationship between his barometer and the stock market are much less definitive.

The chart below shows mixed results for stocks after the threshold has been eclipsed.

Leuthold

Put briefly, this indicator shouldn’t be relied upon to discern the stock market’s next move. The returns are much less definitive.

However, investors should be taking an in-depth look at their bond holdings. The future for debt securities doesn’t look promising.

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