The Stock/Bond Yield Gap
by Jay Kaeppel
STOCKS & COMMODITIES contributor Jay Kaeppel presents an indicator using the yield for high-grade
corporate bonds and the yield for the DJIA to predict the stock market.
Investors have often wondered if some significant information could be gleaned from comparing yields
on stocks to yields on bonds. In theory, at least, it would seem to make sense that if bond yields were
much higher than stock yields, then investment dollars would be drawn to bonds and away from stocks,
thus having a negative effect on stock prices. Likewise, if the difference between stock yields and bond
yields narrowed it would suggest that stocks might become more attractive relative to bonds. Fortunately,
this is one case where theory actually works when applied to realistic situations.
THE GAP AS A TOOL
The stock/bond yield gap (SBYG) has proved to be a useful tool in anticipating favorable and unfavorable
periods for stock prices. Upon examination, this indicator has at least four factors in its favor. First, it is
simple to calculate. Second, interpreting buy and sell signals is equally simple. Third, it serves as a useful
advance warning signal to impending turns in the market. Finally, even though the gap rarely gives
signals near actual bottoms or tops, it has outperformed the Standard & Poor's 500 by a considerable
amount since I began to track it in 1980.