The importance of intermarket analysis
John Murphy
The basic premise of intermarket analysis is that all markets are related. In other words, what happens in one market has an effect on another.
- Commodity prices and bond prices usually trend in the opposite direction. (Commodity prices and bond yields usually trend in the same direction.)
- Bond prices usually trend in the same direction as the stock market.
- Rising bond prices are good for stocks; falling bond prices are bad for stocks. (Falling bond yields are good for stocks; rising bond yields are bad for stocks.)
- The bond market usually changes direction long before stocks do; therefore, the bond market is a leading indicator of potential trend changes in stocks.
- Commodity prices usually trend in the opposite direction of the dollar.
- A rising dollar is bad for commodities; a falling dollar is good for commodities.
- A rising dollar is normally good for U.S. stocks and bonds because it is noninflationary.
- A strong currency attracts foreign money into a country’s stock market.
On a macro level, the four interrelated markets are the commodity, currency, bond, and stock markets. It is not unusual for technical analysts to supplement their stock market analysis with consideration of currency trends (to see where global money is flowing), commodity prices (to gauge inflationary trends), bond charts (to see which way interest rates are moving), and overseas markets (to measure the impact of global market trends).
Market analysts have long understood the impact of interest rates on stocks, for example. Rising interest rates have historically been bad for stocks, especially those in certain rate-sensitive market sectors. Interest rates are affected by the direction of commodity prices. Rising commodity prices are usually associated with rising inflation, which puts upward pressure on interest rates.
The direction of commodity prices is affected by the direction of a country’s currency. A falling currency, for example, usually gives a boost to commodities priced in that currency. That boost reawakens inflation fears and puts pressure on central bankers to raise interest rates, which has a negative impact on the stock market. Not all stocks, however, are affected equally—some stock groups get hurt in a climate of rising interest rates, while others actually benefit in a climate of rising rates.
Global markets play an important role in intermarket analysis as well. For example, the collapse in Asian currencies during 1997 caused a corresponding collapse in Asian stock markets, which had a ripple effect around the globe. Fears of global deflation pushed commodity prices into a free fall and contributed to a worldwide rotation out of stocks into bonds. What started as a downturn in Asian currencies in the summer of that year eventually caused a serious downturn in the U.S. stock market several months later.
During 1999, the opposite scenario played itself out. A sharp rise in the price of oil at the start of that year pushed interest rates higher around the globe as inflation fears resurfaced. A recovery in Asian stock markets also contributed to global demand for industrial commodities like copper and aluminum. The subsequent rise in commodity prices reawakened inflation fears and prompted the Federal Reserve to embark on a series of rate hikes in the middle of the year. That, in turn, had a negative impact on the sectors of the U.S. stock market that are especially sensitive to interest rate direction.
