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.
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 .