Barron’s Confidence Index 

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Barron’s Confidence Index

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The Barron’s Confidence Index is designed to measure investors’ confidence in the stock market. The Barron’s Confidence Index compares the yield of high-grade bonds (usually AAA rated, the highest rating) to the yield of lower-grade bonds (usually BBB rated). This relationship is used to predict price movements in the stock market. The assumption behind this theory is that bond traders are more sophisticated than stock investors, so their actions are assumed to have more insight into future market activity. The Barron’s Confidence Index is determined by dividing the yield of 10 top-grade corporate bonds by the yield of 10 intermediategrade bonds.

Barron’s Confidence Index = (yield on 10 top-grade bonds/yield on 10 intermediate-grade bonds) * 100

Yields on top-grade bonds are always lower than yields on lesser-grade bonds, so this index is always less than 100 percent. The trading range is generally between 80 and 95 percent. Advocates of this ratio watch to see how close the ratio can get to 1, its theoretical maximum value. For instance, if the average yield of the 10 highgrade bonds is 4.5 percent and the average of the intermediate-grade bonds is 5 percent, the Barron’s Confidence Index is 90 percent (4.5%/5% * 100). When investors are confident about the future, they are willing to take more risk and buy more speculative bonds. The price of higher-quality debt is then depressed, which increases the yield, indicating investors’ optimism in the stock market.

When the Barron’s Confidence Index falls to around 80 percent, the outlook for the stock market is bearish. Confidence in the economy is low, prompting investors to buy good-quality debt, which increases prices and lowers yields. The selling of lower-grade bonds decreases their prices and increases their yields. This situation results in an increase in the rate differential between high-quality and lower-quality bonds and a lower Barron’s Confidence Index.

Like many other technical indicators, the Barron’s Confidence Index has not been accurate in predicting stock price movements. Time lags may occur between the indicator and the results; when companies in the Barron’s Confidence Index issue a large supply of bonds, the yields are distorted, which then distorts the indicator.

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