Picture du Jour: Stock markets – it’s all about confidence

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A key requirement for the recent stock market gains to be more enduring and for the bear’s corpse to be put to rest, is the restoration of investor confidence. A few comments regarding this issue are highlighted in this post.

As shown in Sunday’s “Words from the Wise” review, a confidence indicator worth monitoring is the Barron’s Confidence Index. This Index is calculated by dividing the average yield on high-grade bonds by the average yield on intermediate-grade bonds. The discrepancy between the yields is indicative of investor confidence. There has been a solid improvement in the ratio since its all-time low in December, showing that bond investors are growing more confident and have started opting for more speculative bonds over high-grade bonds.

Not surprisingly, a strong historical relationship exists between the Barron’s Confidence Index and the S&P 500 Index’s 12-month rate of change.

Click on the image below for a larger graph.

5-mei-pic2.jpg

The improvement in the Barron’s indicator augers well for the outlook for equities – specifically for the return of confidence – and provides further evidence that US stock markets are mapping out a base development formation. The early January highs and 200 day-moving averages are the next important targets and a break above these levels would signal the completion of the base formation and a secular bottom (as has already been seen in leading markets such as China and Brazil). (The Nasdaq Composite Index is also already above its January high and 200-day line.) Meanwhile, the speed and magnitude of the rally argue for markets to consolidate and possibly retrace some of the past eight weeks’ gains prior to launching an attack on longer-term indicators used to distinguish between primary bull and bear markets .

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5 comments to Picture du Jour: Stock markets – it’s all about confidence

  • Ron Glandt

    “Meanwhile, the speed and magnitude of the rally argue for markets to consolidate and possibly retrace some of the past eight weeks’ gains prior to launching an attack on longer-term indicators used to distinguish between primary bull and bear markets.”

    WHAT DOES THIS SENTENCE MEAN IN PLAIN WORDS? -That it is likely this market will pull back before becoming a bull market???

  • Ron: A pullback or consolidation before finally breaking above long-term indicators such as the 200-day moving average. Although a lagging indicator, the 200-day line is often used as an indication of the market’s primary (bull/bear) trend.

  • bill

    Hi

    How has Barron s Confidence Index behaved during other recovery/bear market phases?

  • I know the R man can change his mind but as a result of his programing, I can’t buy into the secular bottom position until stocks are selling at 7 PE’s and yielding 6 or 7 %, unless he does.

    Winston Churchill would say that was a rule up with which he would not put.

  • Bill: I unfortunately do not have the Barron’s Confidence Index going back all that far, but a study of recessions and corporate bond spreads since the 1950s show that the spread between high-yield and investment grade bonds typically peaks very close to the end of recessions.

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