This week’s indicator is what we call an overbought and oversold indicator. The simplest way to think of it is like a rubber band. Pull it gently and nothing happens. Stretch it far enough and you start to feel the tension build. Keep pulling, and eventually the band reaches a point where it can’t stretch any farther. It snaps back. Markets work in a similar way.
Here’s how it works. The indicator tracks the relationship between the global stock/bond ratio (stock prices divided by bond prices) and measures how far it has drifted from its normal trend. The tool we use is a z-score, which is just a statistical method for measuring how many standard deviations the ratio sits above or below its rolling one-year average. When the z-score pushes into extreme territory, it tells us the rubber band is stretched. When it reverses back inside the band, that snapback is the signal.
For example, I’ve highlighted the most recent signal on the chart. It’s a sell—meaning bonds should be favored over stocks. You can see how after a bullish reversal back in May, the global stock/bond ratio shot higher and had been running hot in recent months. The rubber band then got stretched, the tension built up, and now we’re seeing a snapback lower. Statistically, this is called a reversion to the mean.
Why does this matter? Because history shows that these turning points carry weight. When the z-score falls into oversold territory and then turns upward, global stocks tend to outperform bonds. When it rises into overbought territory and then reverses lower, as it just did, the opposite has been true. The performance box at the bottom shows the difference in returns during these states, and it is clear that the global stock and bond ratio experiences negative returns in this environment.
Okay, so what’s the bottom line behind all this? Well, this indicator serves as a good reminder that markets can only drift so far from trend before pressure builds and the rubber band wants to snap back. Stocks can only outperform bonds for so long, and vice versa, before something gives. The market is simply telling us that leadership may be shifting.
And if you want a lighthearted way to remember all this, think back to the Spinners’ classic “The Rubberband Man.” Markets stretch, twist, and pull the same way. Eventually they snap back into rhythm. This indicator simply helps us see when the tension is getting too high.
This is intended for informational purposes only and should not be used as the primary basis for an investment decision. Consult an advisor for your personal situation.
Indices mentioned are unmanaged, do not incur fees, and cannot be invested into directly.
Past performance does not guarantee future results.