Intermarket analysis. "Intermarket analysis

John J. Murphy

Intermarket analysis. Principles of interaction of financial markets

Intermarket Analysis: Profiting from Global Market Relationships

Published with the assistance of the International Financial Holding FIBO Group, Ltd.

Translation LLC "LF-TEAM"

Editor V. Ionov

Project Manager A. Polovnikova

Corrector O. Ilyinskaya

Computer layout S. Novikov

Cover design Creative Bureau "Howard Roark"

Murphy J.

Intermarket analysis: Principles of interaction of financial markets / John Murphy; Per. from English – M.: Alpina Publisher, 2012.

ISBN 978-5-9614-2717-2

All rights reserved. No part of the electronic copy of this book may be reproduced in any form or by any means, including posting on the Internet or corporate networks, for private or public use without the written permission of the copyright owner.

Dedicated to Anne, a great poet, and Tim, a great brother.

Acknowledgments

I thank everyone who helped produce this book: Pamela van Giessen, executive editor at Wiley, who encouraged me to take up the pen; Jennifer McDonald and Joanna Pomerantz, whose efforts made everything fall into place; Heidi Shelton and Pete Boehmer of Stockcharts.com for their excellent charting; John Carder of Topline Investment Graphics for his innovative presentation of historical charts; Tim Murphy for his help with cover design and CGI; market analysts who generously allowed their work to be used, including Ned Davies, Ken Fisher, Ian Gordon, Martin Pring and Sam Stovall. Finally, I am grateful to the Maktools family, who supported me morally throughout the writing of the book.

Introduction to Intermarket Analysis

In 1990, I completed a book entitled Intermarket Technical Analysis: Trading Strategies for the Global Stock, Bond, Commodity and Currency Markets. I wanted to show how closely financial markets are interconnected at the national and global levels. The book emphasized that technical analysts need to broaden their perspective and consider intermarket relationships. Analyzing the stock market, for example, without considering trends in the dollar, bond and commodity markets is simply incomplete. Financial markets can be used as leading indicators of other markets and sometimes as confirmatory indicators of interconnected markets. Because the premise of this book rejected the traditional focus of the technical analyst community on separate market, some doubted whether the new approach could be applied to technical analysis. Many have asked whether cross-market relationships even exist and whether they can be used in the forecasting process. The possibility of interconnection between global markets was also viewed with skepticism. How everything has changed in just a decade!

Intermarket analysis is currently considered one of the areas of technical analysis and is becoming increasingly popular. In 2002 the magazine Journal of Technical Analysis conducted a survey of members of the Association of Technical Analysts to assess the relative importance of technical disciplines in a technical analysis curriculum. Intermarket analysis ranked fifth among 14 disciplines. Over the past 10 years, the idea of intermarket interaction has come a long way.

Events of the 1980s

My previous book focused on events in the 1980s, starting with collapse of commodity markets. It ended the hyperinflationary period of the 1970s, when physical assets such as commodities soared and paper assets such as bonds and stocks fell. The commodity market peak in 1980 began a 20-year deflationary trend that coincided with strong gains in the bond and stock markets. The most notable financial event of the 1980s. The stock market crash of 1987 is a textbook example of how markets interact and shows how important it is to pay attention to interconnected markets. The surge in commodity prices and collapse in bond prices in the first half of 1987 directly signaled an impending stock market decline in the second half of that year. Three years later, in 1990, when the previous book went to press, global financial markets were just beginning to react to Iraq's invasion of Kuwait in August. Gold and oil prices rose sharply and stock markets fell around the world. It is noteworthy that 13 years later (in early 2003), market analysts, in anticipation of a new war in Iraq, were actively studying the market reaction in 1990-1991. looking for parallels. History repeats itself even in the sphere of intermarket interaction.

The collapse of the Japanese bubble in 1990

The consequences of another significant event that occurred in the early 1990s are still being felt globally more than 10 years later. Then the bubble burst in the Japanese stock market. Its collapse marked the beginning of a 13-year decline in this market (which represented the world's second largest economy) and a period deflation(reducing prices for goods and services). A decade later, Western central banks turned to the Japanese deflation model in search of ways to combat the growing deflationary processes in the economies of Western countries. Some of the graphs presented in this book also support the view that deflation in Japan was a major factor communication disruptions between bonds and stocks in the United States a year later, when the rise in bond prices that began in 2000 coincided with a fall in stock prices.

Third anniversary of the 2000 market peak.

March 10, 2003 marked the third anniversary of the collapse of the Nasdaq bubble, which marked the beginning of the worst bear market in decades. The S&P 500's 50% drop was the worst since 1974. The Nasdaq's 78% loss was the largest since the stock market crash of 1929-1932. during the height of the Great Depression. Market historians had to return to the study of these two periods in order to gain some understanding of market behavior. The comparison, however, was complicated by the fact that the economic reasons were different. Stock market crash in the 1970s. was associated with rising commodity prices and hyperinflation, while the fall in stock prices in the 1930s. occurred in conditions of economic deflation. While both situations are bad for stocks, deflation is harder to counteract.

In 1998 the word deflation, which had not been heard since the 1930s, sounded again. This occurred as a result of the Asian currency crisis that gripped the world in 1997 and 1998. Within five years, deflation had spread beyond Asia and hit bond and stock markets around the world, including the United States. More than any other factor, it changed the inter-market relationships that had existed over the previous 40 years. It was these changes that made me write this book - to show what continues to work according to the old intermarket model and what does not. Intermarket analysis is based on the interactions (or relationships) between markets. However, the situation in this area is not static. The relationships between financial markets may change over time. The changes are not random; they usually have a good reason. The main reason for some of them, which began in the late 1990s, was the growing threat of deflation.

Deflationary scenario

I supplemented the new edition of the book “Technical Analysis of Financial Markets” in 1999 with a chapter on intermarket analysis, which examined historical relationships that have operated over several decades. I have also added a new section called "Deflationary Scenario". It described the collapse of Asian currency and stock markets that began in mid-1997. The sharp decline had a particularly negative impact on global commodity markets such as copper, gold and oil. For the first time in a long time, analysts were worried that the favorable era slowing inflation(when prices rise at a lower rate) will end and a period of harmful deflation(when prices for goods actually decrease). The reaction of markets to this initial threat of deflation determined the pattern of intermarket interactions over the next five years. Commodity prices fell and bond prices rose. This was nothing new - falling commodity prices usually lead to higher bond prices. What has changed is the relationship between bonds and stocks. Throughout 1998, stocks sold off across the board, with money flowing into U.S. Treasuries for safety. In other words, stocks fell while bonds rose. This was unusual and represented the largest change in the intermarket model. The slowdown in inflation (which occurred from 1981 to 1997) is bad for commodities, but good for bonds and stocks. Deflation (which began in 1998) is usually good for bonds and bad for commodities, but this time it was bad for stocks as well. In deflation, bond prices rise and interest rates fall. Lower interest rates, however, are not supporting stocks. That's why the Federal Reserve's repeated interest rate cuts in the 18 months after January 2001 failed to stem the stock market's decline from its peak in early 2000.

Intermarket analysis is a branch of technical analysis that studies the correlation between four major asset classes - stocks, bonds, commodities and currencies. John Murphy in his classic book Intermarket Analysis (Intermarket AnalysisJohn Murphy notes that technical analysts can use these relationships between different markets to identify the stages of business cycles and improve the quality of their forecasts. There is a clear relationship between stocks and bonds, bonds and commodities, and commodities and the US dollar. Knowing these relationships can help a technical analyst determine the stage of the investment cycle, select the best sector and avoid the weakest sectors, which will help him to regularly increase his.

Inflationary relationships

The relationships between markets depend on inflationary and deflationary forces. In a "normal" inflationary environment, stocks and bonds are positively correlated. This means that both of these asset classes are moving in the same direction. The world was in an inflationary environment from the 1970s to the late 1990s. Here are the main intermarket relationships in an inflationary environment:

POSITIVE relationship between bonds and stocks. Bonds tend to change direction before stocks

INVERSE relationship between bonds and commodities

A positive relationship means that when one asset goes up, the other goes up too. In an inverse relationship, if one asset rises, the other falls. Interest rates go up when bonds go down.

In an inflationary environment, stocks react positively to falling interest rates (rising bond prices). Low interest rates stimulate economic activity and accelerate corporate profit growth. It should be borne in mind that the term “inflationary environment” does not mean galloping inflation. It simply indicates that inflationary forces are stronger than deflationary forces.

Deflationary relationships

Murphy notes in his book that around 1998, the world shifted from an inflationary environment to a deflationary environment. It began with the collapse of the Thai baht in the summer of 1997 and quickly spread to neighboring countries. This event was called the Asian Currency Crisis. Asian central banks have raised interest rates to support their currencies. But high interest rates have wreaked havoc on these countries' economies and only made the problem worse. The resulting threat of global deflation caused capital to flow from stocks to bonds. Stock prices plummeted, Treasury bonds soared, and US interest rates fell. This led to a breakdown in the relationship between stocks and bonds that lasted for many years. Major deflationary events continued with the collapse of the Nasdaq bubble in 2000, the collapse of the housing bubble in 2006, and the financial crisis in 2007.

Deflationary threats force capital to move into safer assets, which leads to growth in the bond market

Intermarket relationships in a deflationary environment are essentially the same, with one exception. Stocks and bonds are inversely correlated during such a period. This means that stocks rise when bonds fall and vice versa. Therefore, stocks have a positive correlation with interest rates. That is, stocks and interest rates will rise together.

Obviously, deflationary forces change the entire dynamics of the market. Deflation is negative for stocks and commodities, but positive for bonds. Rising bond prices and falling interest rates increase deflationary threats, which puts pressure on stock prices, forcing them lower. Conversely, lower bond prices and rising interest rates reduce deflationary threats, which is positive for stocks. Below is a list of key intermarket relationships in a deflationary environment.

REVERSE relationship between bonds and stocks

INVERSE relationship between commodities and bonds

POSITIVE relationship between stocks and commodities

INVERSE relationship between the US dollar and commodities

US dollar and goods

Although the dollar and the foreign exchange market are part of intermarket analysis, the dollar can be considered a rather unpredictable factor. A weak dollar does not have a bullish effect on stocks unless it is accompanied by a major rise in commodity prices. Obviously, rising commodity markets have a bearish effect on the bond market. A weak dollar typically causes the bond market to fall. A weak dollar stimulates the economy, making exports more profitable. This benefits the shares of large multinational corporations, which receive a significant part of their revenue through sales in other countries.

What is the impact of a stronger dollar? The currency of any country is a reflection of its economy and national balance. Countries with strong economies and strong balance sheets have stronger currencies. Countries with weak economies and high debt loads have weaker currencies. A rising dollar puts negative pressure on commodity prices because many commodities, such as oil, are quoted in dollars on world markets. Bonds benefit from lower commodity prices because it reduces inflationary pressures. Stocks can also benefit from lower commodity prices because they lower commodity prices.

But not all products are the same. Oil in particular is susceptible to supply disruptions. Instability in oil-producing countries or regions usually causes oil prices to rise. Rising prices as a result of supply disruptions have a negative impact on the stock. At the same time, growth driven by increased demand could have a positive effect on stocks. The same applies to industrial metals, which are not as susceptible to supply disruptions. Therefore, technical analysts can use industrial metal prices to better understand the state of the economy and the stock market. The rise in prices is a reflection of growing demand and a recovering economy. Falling prices indicate declining demand and a weak economy. In the chart below, you can see a clear positive relationship between industrial metals prices and the S&P 500.

Industrial metals and bonds are rising for various reasons. Metal prices rise when the economy grows and/or when inflationary pressures increase. Under these conditions, bonds fall. And they rise when the economy is weak and/or deflationary pressure is created. The correlation of these two markets can help to better understand the strength/weakness of the economy and inflation/deflation. The ratio of industrial metals prices to bond prices will rise when a strong economy and inflation dominate. And it will decline in conditions of deflation and a weak economy.

Rising metals/bonds ratio favors inflation and economic growth

Falling metals/bond ratio favors deflation and weaker economy

conclusions

Intermarket analysis is a valuable tool for long- and medium-term analysis. Although the intermarket relationships discussed above work quite well over long periods of time, they are subject to drawdowns, that is, periods when such relationships do not work. Large-scale events such as the euro crisis or the US financial crisis can disrupt certain relationships for several months. In addition, the tools discussed in this article should be used in conjunction with other methods of technical analysis. A chart of industrial metals and bond prices can be included in your set of broad market indicators designed to gauge the overall strength or weakness of the stock market. To make a qualitative assessment of market conditions, one should not use any one indicator or one relationship.

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Year of issue: 1999

Genre: Finance, FOREX (Forex)

Publisher:"Diagram"

Format: DjVu

Quality: Scanned pages

Number of pages: 317

Description: The book “Intermarket Technical Analysis” is the result of a long-term study of intermarket relations. The graphs presented in it clearly demonstrate the interdependence of various market sectors and convincingly prove the need to take this interdependence into account. In my opinion, the main advantage of intermarket analysis is that it expands the field of view of the technical analyst. Working in the market without resorting to intermarket analysis is like driving a car without looking in the mirrors. In other words, it is extremely dangerous. Cross-market analysis is applicable to all markets in all regions of the world. It enriches technical analysis by examining external factors, allowing for a deeper understanding of the nature of market forces and a more holistic view of the operation of global market mechanisms. Studying the dynamics of adjacent markets has the same goal as using traditional technical indicators - to determine the future direction of price movements. Intermarket analysis does not replace other technical tools, it simply adds an additional dimension to technical analysis. It also draws the technical analyst's attention to previously foreign issues such as interest rate and inflation dynamics, Federal Reserve policy, economic analysis, and business cycles.
The book “Intermarket Technical Analysis” is the initial rather than the final stage in the development of intermarket analysis. Much remains to be done to fully understand how different markets relate to each other. Although the principles described in this book work well in most situations, they should be understood as general principles and not as rigid mechanical rules. The scope of cross-market analysis is great: it forces us to stretch our imagination and broaden our horizons, but the potential benefits of this greatly compensate for the additional effort. Intermarket analysis has a great future, and I hope that after reading this book you will agree with me. Book's contents

New horizons in technical analysis
All markets are interconnected
How does this affect technical analysis?
Purpose of this book
Four market sectors: currencies, commodities, bonds and stocks
Basic prerequisites for cross-market research
Intermarket analysis as a source of auxiliary information
Relying on external rather than internal data
Particular attention is paid to the analysis of futures markets
The important role of commodity markets
Key relationships between markets
Book structure
The 1987 crisis from the point of view of intermarket relations
Low inflation and rising stock market
The collapse of the bond market is a warning signal for the stock market
The role of the dollar
Brief summary of key intermarket relationships
Leading and lagging dollar exchange rate
Commodity yen and bonds
The key role of inflation
Economic justification
Development of markets in the 80s
Bonds and the CRB Index after 1987
How a technical analyst can use this information
Combined technical analysis of commodity and bond markets
Using Relative Strength Analysis
The role of short-term interest rates
The Importance of Treasury Bill Market Dynamics
All markets need to be monitored
Some correlation values
Relationship between bonds and stocks
Financial markets are on the defensive
Fundamentals in the bond (1981) and stock (1982) markets
Bonds as a leading indicator of stocks
Bond and stock markets should be analyzed together
How to account for long lead times?
Short-term interest rate markets and the bond market
The "three steps and fall" rule
Historical perspective
The role of the business cycle
What is the role of the dollar?
Commodity markets and the dollar
The dollar and commodity yen are moving in opposite directions
Commodity market trends as an indicator of inflation
The relationship between the dollar and the CRB index
Lead problem
The key role of the gold market
Foreign currencies and gold
Gold as a leading indicator of the CRB index
Combined analysis of dollar, gold and CRB index
The relationship between the dollar, interest rates and stocks
Commodity markets: lagging or leading?
Dollar and short-term interest rates
Relationship between long-term and short-term rates
Relationship between dollar and bond futures
Relationship between dollar and treasury bill futures
The relationship between the dollar and the stock market
Sequence of changes in the dollar exchange rate, interest rates and stock market
Dependence between commodity and stock markets
Gold and the stock market
Gold is the key to understanding the most important intermarket connections
Interest rate difference
Commodity market indices
Commodity prices, inflation and Fed policy
How the CRB index is constructed
Study of correlations between different groups
Markets for grains, metals and petroleum products
Relationship between the CRB Futures Price Index and the CRB Spot Yen Index
How the CRB Yen Spot Index is constructed
Dependence between yen on industrial raw materials and food
Journal of Commerce (JOC) Index
Graphical comparison of various commodity indices
Dependence between yen on food and industrial raw materials
JOC Index and Yen Index for Industrial Raw Materials
Relationship between CRB Yen Futures Index and JOC Index
Relationship between interest rates and commodity indices
CRB Index - a more balanced picture
CRB Yen Futures Group Indexes
Relationship between the CRB index and the group indices of grains, metals and energy
Dependence between energy and metals markets
The role of gold and oil markets in the system of intermarket connections
The relationship between metals and energy futures and interest rates
Commodity markets and Fed policy
Relationship between the CRB index and the PPI and CPI indices
Relationship between interest rates and the CRB, PPI and CPI indices
Chapter 8. International markets
World markets
World markets crash in 1987
British and American stock markets
American and Japanese stock markets
World interest rates
Global bond markets and global inflation
World intermarket indices
Commodity index of the Economist magazine
Share groups
Stock groups and corresponding commodity markets
Relationship between the CRB index and the bond market
The relationship between the yen of gold and the shares of gold mining companies
Why do golden Akiyas shine brighter than gold?
The relationship between oil yen and oil company shares
A New Frontier for Gap Analysis
Interest Rate Sensitive Stocks
Relationship between savings and loan stocks and the Dow Jones Industrial Average
Relationship between savings and loan stocks and bonds
Relationship Between Savings and Loan Shares and the CRB Index
The relationship between the shares of the largest banks and the aggregate index of the New York Stock Exchange
Dependence between shares of gold mining companies and major banks
Aou-Ajons Utility Index as a leading indicator of the stock market
Relationship between the Dow Jones Utilities and Industrial Indices
Bond market outpaces utility index peaks
Relationship between the utility index and the bond market over a longer period
Relationship between the CRB index, the bond market and the utility index
Bond Market, Dow Jones Utilities and Industrial Indices
Analysis of the relative strength of commodity markets
Group Analysis
Individual ranking
Ratio Analysis
Relative Strength Ratios
Comparison of groups
Graphs of product group coefficients
Analysis of a group of energy carriers
Analysis of a group of precious metals
Gold/silver ratio
Relationship between gold and oil
Individual ranking of product markets
Analysis of some commodity markets
Commodity markets and asset allocation
CRB/bond ratio analysis
Relationship between CRB index and stocks
CRB/bond ratio outperforms CRB/stock ratio
The role of futures in asset allocation
Comparison of four futures sectors
The Importance of Managed Futures Accounts
Why are futures portfolios poorly correlated with stock and bond portfolios?
Commodity futures as an asset class
What is the degree of risk?
Shift of the efficient frontier
Intermarket Analysis and the Business Cycle
Chronological sequence of changes in the bond, stock and commodity markets
The gold market is outperforming other commodity markets
When do commodity markets turn - first or last?
Six stages of the business cycle
The role of bonds in economic forecasting
Indices with large and small lead times
Prices for stocks and commodities as leading indicators
Copper as an economic indicator
Copper and the stock market
The Myth of “Program Trading”
Program trading is a consequence, not a cause
What is the reason for program trading?
Programmatic trading is a scapegoat
Examples from one trading day
Graphical representation of morning market dynamics
New direction
Intermarket technical analysis: focus on external factors
Impact of global trends
Technical Analyst and Intermarket Forces
Basic intermarket principles and connections
Intermarket analysis and futures markets
Commodity markets as the missing link
Computerization and globalization
Intermarket analysis - a new direction
Literature

Liquidity determines whether we can enter and exit the market quickly and efficiently.

Trading volumes and spreads are key indicators of liquidity.

They reflect the activity of participants and the presence of major players. As a rule, the market at any given time represents a confrontation between several large players, but if there is no such confrontation, then the market immediately degrades. Liquidity is maintained by market makers - these are those market participants who have undertaken to maintain price quotes. When market makers leave the market, it becomes very fragile and begins to move very volatile. Market liquidity also decreases sharply in cases where very large players appear on one side of it, such as Sberbank or Vnesheconombank, who actually dictate prices to other participants. In this case, there is a huge gap between how the market should behave and how it actually behaves.

Liquidity is the main factor we consider when selecting markets. We want to be sure that the spread between the bid and ask prices is acceptable for the number of shares or futures contracts that we intend to trade.

The best measure of liquidity is volume, and for the futures market still open interest. I recommend that you regularly monitor them for the financial instruments you trade.

Until the early 90s of the last century, when analyzing the movement of stock prices, traders mainly focused on studying price charts and the behavior of technical indicators. The situation changed with the appearance of John J. Murphy's book Intermarket Technical Analysis in 1991, after which a more universal approach took into account the interaction of various financial markets.

John Murphy's cross-market analysis examines the interactions between three major asset classes—commodities, bonds, and stocks.

It is recommended to monitor the movement of commodity markets, even if you do not intend to trade in them, since trends in commodity prices speak volumes about the strength or weakness of the economy, the direction of inflation and changes in interest rates.

Important changes in price trends in commodity markets tend to outpace changes in more general measures of inflation—the consumer price index and the producer price index.

A generally accepted indicator of the direction of movement of commodity prices is the CRB Commodity Futures Price Index. (you can watch its changes here: http://stockcharts.com/charts/gallery.html?$CRB). Although changes introduced at the end of 1995 reduced the number of commodity markets in the index from 21 to 17, the index still represents the bulk of commodity sectors, including precious metals, energy, grains, livestock, industrial and tropical goods.

A comparison of any long-term chart of the CRB index and bond prices will show that they tend to move in opposite directions.

One of the assets can act as a warning signal about the possibility of a worsening situation in the other.

So, for example, at the turn of 1993. commodity prices fell and bond prices rose. However, at the beginning of 1993. The CRB index turned upward and continued its ascent throughout the year. The simultaneous increase in prices for goods and bonds lasted for several months, until the 4th quarter of 1993. How did it all end? And this divergence ended with the most dramatic fall in the bond market in half a century.

Reversals in the CRB index often outpace reversals in the bond market.

The prices of the commodities included in the CRB index behave differently. Copper and aluminum are especially sensitive to changes in economic conditions because they are used in the automotive industry and home construction. As a result, they have a stronger correlation with bond prices than other commodities that are more dependent on weather conditions, such as grains.

Particular attention should be paid to the state of affairs in two markets – gold and oil.

Gold is considered to be a leading indicator of inflation, so it carries an important psychological load. The Federal Reserve System also closely monitors movements in the gold market - they allow us to judge how correctly monetary policy is being carried out.