lecture 12: intermarket analysis Flashcards
The basic premise of intermarket analysis
all financial markets are linked in some way
Although the relationships may shift on occasion, they are always present in one form or another
why are all financial markets are linked?
because they are all manifestations of the economic cycle
The economic cycle affects a market in one way and another market in another way with all markets impacting each other
The 4 market groups that we will discuss
currencies
commodities
bonds
stocks
Stock v.s. Bond Cycle
all the phases
Phase 1: Bonds up, stocks down
Phase 2: Bonds up, stocks up
Phase 3: Bonds down, stocks up
Phase 4: Bonds down, stocks down
Phase 1: Bonds up, stocks down
When the economy is weak, bonds usually do better than stocks for a while because the earnings environment is poor
Phase 2: Bonds up, stocks up
Then stocks start to move up because lower interest rates get investors to buy in anticipation of an improved economy and therefore, better earnings.
Phase 3: Bonds down, stocks up
Later the economy is actually strengthening, with increased credit demand and improved pricing and earnings are rising
Phase 4: Bonds down, stocks down
Eventually, higher interest rates cause investors to be concerned that economic activity will slow down and therefore, earnings will soon weaken
When looking at commodities, why do we always look first to gold?
what is a more representative benchmark to use?
because it is a leading indicator and a gauge of expected inflation
a more representative benchmark would be to use the CRB Index
Oil is also a good proxy for commodities
relationship between bond prices and commodities
inverse relationship
Rising commodity prices (as measured by the CRB index) mean what?
an indication of economic strength
an early inflation warning that would push interest rates higher (bond prices lower)
thus also offering an early warning to stock trader
A ↑ USD means what?
a decrease in future inflation, resulting in commodities selling off, which is in turn good for the bond and stock markets
negative for commodities since many commodities are priced in USD
A ↑ in the CRB index means what?
generally bad for the bond and stock markets as it signals increased inflation and possible increases in interest rates
that the inverse relationship between commodities and bonds & stocks holds true during inflationary & disinflationary periods, but not necessarily during deflationary periods
why?
In a deflationary environment, decreasing commodities are generally positive for bonds, but not necessarily good for stocks
Disinflationary scenario: Commodities ↓
Bonds ↑
Stocks ↑