Where's the Alpha At?

From the desk of Steve Strazza @Sstrazza and Ian Culley @Ianculley

Back in August, we presented two opposing views of the relationship between stocks and bonds.

The question was, after running into resistance at a key extension level, in which direction would the $SPY/$TLT ratio resolve?

Would stocks break higher relative to bonds, in the direction of the underlying trend?

Or would the ratio roll over in favor of bonds? It would certainly be a logical level for a trend reversal...

Fast forward two months, and we finally have our answer.

Turns out it was the former -- stocks are breaking higher relative to bonds. Here's a look:

An upside resolution indicates stocks have begun to outperform bonds again. Now, bulls just need to see this ratio stick the landing, in which case we’d anticipate a strong leg up from here.

And if we’re in an environment where the intermarket landscape favors stocks over bonds, what are the implications for risk assets?

For starters, the alpha is still in the stock market. Meanwhile, bonds are rolling over as rates resolve to new highs across the board.

If this is the case -- which we think it is -- we want to be buying the former and selling the latter.

We've already been buying stocks, albeit selectively, all year.

But now that we have a clear directional bias for bonds, let's dig in and see how we can express this bearish thesis in the market.

As the market rewards investors for buying stocks over their safer alternatives, we like the short side of the 7-10 Year US Treasuries ETF $IEF.

After it failed to close the gap from February, it's been sliding back toward a key area of former resistance turned support around 114. We want to sell IEF on weakness below this critical level with a downside target of 108.50 in the coming months.

But we only want to be short on a decisive close below 114.

With rates on the rise and the SPY/TLT ratio resolving higher, it's clear where the alpha is. It's also clear where it's not!

The market is telling us that money is flowing out of bonds and into stocks. It's our job to listen to that message and react by allocating our capital where it's going to be treated best.

We’ll keep our eyes on this crucial relationship and keep you updated as the intermarket picture continues to develop.

But, from a macro view, seeing both yields and the stocks/bonds ratio resolve higher from such key levels can only be interpreted as bullish for risk assets in general.

As always, let us know what you think. We love hearing from you.

Thanks for reading, and be sure to download our Bond Report below!