Did Bonds Warn About Stocks in 2008 and Are They Reiterating It Again Today?

02/09/2016 7:00 am EST

Focus: STOCKS

Chris Ciovacco of SafeHaven takes a historical look at the performance of Treasuries relative to the S&P 500 in 2007-2008 and outlines how the current ratio aligns with several bigger picture concerns.

When investors are fearful, common sense tells us demand picks up for more conservative assets, which is exactly what happened early Monday morning. From Bloomberg:

"Signs of distress in financial markets are gathering force as concern over the state of the global economy deepens. The Standard & Poor's 500 Index declined as much as 2.2%, as US shares joined a retreat in European and emerging-market stocks. Investors sought the safest assets, sending yields on Treasury 10-year notes to the lowest level in a year and those on Germany's 10-year bunds to the lowest since April. Meanwhile, yields on bonds of Europe's most-indebted countries rose, while the cost of protecting against default by US junk-rated companies climbed to the highest since 2012."

Red Flags in 2008

If you felt the economic outlook was uncertain and you wanted a relatively high degree of safety of principal, what investment might be appealing? Bonds with longer maturities that lock in rates and have a low probability of default, which sounds a lot like long-term US Treasuries (TLT). When investors are very pessimistic and fearful, return of principal becomes highly important. Therefore, when fear increases we would expect to see defensive bonds outperform growth-oriented stocks. That is exactly what started to happen in a fairly convincing manner in late June 2007, when the S&P 500 was trading at 1,310. After the warning from bonds, the S&P 500 (SPX) (SPY) dropped an additional 42%.

chart
February 04, 2016
Click to Enlarge

What Is the Ratio Telling Us Today?

The recent spike in the demand for Treasuries relative to the demand for SPY aligns with the bigger picture concerns.

chart
February 04, 2016
Click to Enlarge

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By Chris Ciovacco, Contributor, SafeHaven

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