When it comes to financial markets, central banks matter. They’re a big player. What they do affects almost everything in the economy, so it’s important to keep an eye on their moves and know their policies.
That’s where this week’s indicator comes into play. It uses something called the Central Bank Policy Composite (shown as the orange line on the bottom clip of the chart). This indicator tracks changes in interest rates from the big four central banks: the Federal Reserve, Bank of Japan, Bank of England, and the European Central Bank. These central banks adjust their rates in response to economic conditions, typically either tightening (raising rates) or easing (cutting rates).
Why’s that important? Because historically, when central banks are tightening their policies, it signals confidence in the economy. That’s a good environment for stock returns. But on the flip side, when the economy is cooling, central banks ease up by cutting rates to stimulate growth. In that scenario, bonds tend to do better than stocks.
We can see how this works by looking at the top clip of the chart, showing the ratio of global stock returns to bond returns. When the line is climbing, stocks are outperforming bonds. But when it’s falling, bonds are winning the race. As you can see by the arrows, when the indicator triggers “buy” signals, the ratio tends to climb (meaning stocks outperform bonds). And when there is a “sell” signal, the ratio tends to fall (meaning bonds outperform stocks).
Where’s the indicator right now? Well, the 12-week smoothing of the composite recently dropped below its 154-week smoothing by more than 0.8 points. Yep, that was enough to trigger a bearish signal for the indicator.
In other words, the current trend is favoring bonds over stocks as central banks around the world are starting to ease off the gas pedal and lower interest rates.
Now, that doesn’t mean stocks will do poorly in this environment; rather, it just means bonds will likely do better.
Of course, this is just one indicator; one piece of the puzzle. But when global central banks start making moves, it’s worth paying attention.
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.