After another brutal day yesterday, stocks are attempting to stabilize this morning. Yesterday, stocks fell beneath their 200 day moving average, and the S&P 500 index is currently battling over this significant level once more. If stock prices pull back and close once again below this level, it will not be a positive forward indicator for near term stock prices. If stocks made a decisive move lower from here, that could eventually help the flow of money head into the bond market, which would be good news for mortgage interest rates. However, bond prices seem to be stuck beneath their 50 day moving average. They would need to overcome this level for mortgage rates to improve. Its not likely to see that happen ahead of Friday’s Bureau of Labor Statistics (BLS) jobs report. However, if the report shows below expectation job gains, that could provide the needed catalyst to push prices above this critical level.
There are several forward indicators that I look at when anticipating the direction of stock and bond markets. One key indication for the longer term direction of stocks that I consider is the P/E ratio of the S&P 500 stock index relative to the rates of returns offered in the bond market. Currently, the S&P 500 price/earnings (P/E) ratio is near 25. This is down from where it was a few short days ago. This means that the market is earning a 4% return on earnings (not to be confused with the rate of growth in stock prices). In other words, every dollar invested (price) is earning $.04 (earnings). When the P/E ratio of the S&P 500 narrows compared to the rate of returns offered in the bond market, many investors will choose to invest in the safer option (the bond market). This can cause stock prices to fall. Well, as interest rates increase, the spread between the two is narrowing. This would generally suggest a pull back in stock prices to re-align the P/E ratio to a more attractive level.
With bond prices unable to break above their 50 day moving average, we will maintain our locking bias.