Intermarket Analysis
Examines various related asset classes, including stocks, bonds, commodities, and currencies.
What Is Intermarket Analysis?
Intermarket analysis examines various related asset classes, including stocks, bonds, commodities, and currencies. The analysis is carried out to help identify the strengths or weaknesses of the asset type under consideration.
Financial market analyst John Murphy first presented this idea in his work "Trading with Intermarket Analysis." Murphy claims traders can gain from examining the connections between various asset types.
Investors can use Intermarket analysis to determine the stage of the investing cycle and the best and worst-performing asset groups.
To determine the strength or weakness of the financial markets or asset classes under consideration, Intermarket analysis looks at several linked financial markets and asset classes.
By considering other markets or assets closely related to the market or asset under evaluation, this type of analysis goes beyond simply examining each market or asset in isolation.
For example, when examining the US stock market, an investor might examine related markets like the bond market, commodity prices, and the US currency.
The US stock market frequently experiences a direct impact from commodity costs. As a result, combining commodity and stock analysis can be used to forecast the path of the stock market.
Therefore, it is important to comprehend changes in related markets better to understand the U.S. stock market's potential future path. For example, commodity prices may have an impact on it.
Although it is frequently categorized as a subset of technical analysis, intermarket analysis should be deemed fundamental because it relies more on relationships to provide a broad sense of direction.
Market Analysis Intermarket Correlation
Intermarket research can be done in various ways, including mechanically and according to rules. With the help of available data, chart comparisons, or a spreadsheet, analyzing the Intermarket relationships between two or more variables is typically feasible.
Most traders and investors use correlations to examine one variable's Intermarket connection with another variable in a different data set. The level of correlation between the variables determines the connection's strength between them.
1. Favorable Correlation
The correlation between the two variables is either positive, negative, or zero.
A positive correlation indicates that the two factors frequently move together. For example, the correlation value may reach +1.0, which would be the ideal level of positive correlation. This would imply that two assets or asset classes move in lockstep with one another in the realm of investing.
Note
A perfect connection is extremely unlikely.
Two factors are statistically significant to each other when their correlation is between +0.7 and +1.0. Investors deciding whether to buy or sell a security may find it very helpful to identify such connections through Intermarket analysis.
2. Negative Correlation
A negative correlation, also called inverse correlation, shows a negative connection between two variables.
Negative correlation numbers can be as low as -1.0. However, their relationship is significant when the correlation is between -0.7 and -1.0.
A negative correlation also means that the factors will move in opposition to each other.
3. Zero Correlation
It is a sign of a weak relationship between the two variables when the relationship is near zero. The relationship between the two variables is unstable and cannot be depended upon to provide trading guidance if it shifts from positive to negative (or vice versa).
Essentially, the factors do not reliably correlate with one another.
Relationships Between Deflation and Inflation
The analysis of a relationship between intermarkets is significantly impacted by inflationary and deflationary forces, among other important factors.
Some of the most clearly characterized Intermarket relationships affected by inflation and deflation are those between bonds and commodities, stocks and bonds, and commodities with the US dollar.
1. Relationships That Are Inflated
Stocks and bonds typically have a favorable correlation when inflation is present. This is because once an asset's worth increases, the other one does too.
Bond prices often reverse course before stock prices do, so a change in bond prices' direction could signify a shift in the tendency for stock prices soon.
Furthermore, the US dollar and commodities and bonds and commodities usually have an inverse connection when there is inflation; i.e., one asset type's value increases while the other's value decreases.
2. Relationships That Are Deflated
Bonds and stock prices typically have an inverse connection in a deflationary climate. This results in a favorable correlation between stock prices and interest rates.
The US dollar and commodity prices, as well as bonds and commodities, have an inverse connection. These offer the same possibilities that an inflationary climate did. In a deflationary climate, stock and commodity prices only correlate positively.
Intermarket Analysis's Value
Intermarket analysis can give insight into how financial marketplaces will develop in the future. Finding the correlations between different asset classes can be very helpful in confirming the likely direction of the asset under consideration.
For example, correlations between specific stocks can shed light on the beginning of a new pattern. This can help investors decide if it’s a better financial decision to either sell their current holdings or buy new ones in a good position to profit from a change in the trend.
However, no technique for asset analysis is intended to be the only technique used. Intermarket analysis works best when combined with other analytical methods or instruments. Additionally, correlations discovered through Intermarket research may not always be stable.
Correlations may alter as economic circumstances change. For example, asset classes may no longer have a statistically significant relationship with one another if previously positive correlations between them turn negative or disappear entirely.
Similar markets are also subject to Intermarket research. For instance, a spread between oats and maize can be used to profit from two somewhat interchangeable commodities.
Sometimes the market for a particular commodity becomes comparatively illiquid, making it challenging to hedge a position. For example, due to the dearth of liquidity in the Canadian bond futures markets, holders of Canadian cash bonds frequently use US bond futures as a hedge.
Finally, the Intermarket category includes studying an index's constituent parts. Individual correlations between the commodities that make up the CRB Index are possible. The relative strength analysis can identify the top and lagging commodities.
The same is true in the stock market, where major averages are used to compare sector groups. Instead, individual stocks are compared to their respective sectors on a micro level.
For example, the stock analysis, such as that of chocolate manufacturer Hershey Foods, should consider the general market, its main raw material - cocoa, interest rates used to fund operations and debt, and foreign exchange rates used when calculating earnings abroad.
Each of these marketplaces impacts the bottom line of the shareholders.
Intermarket Analysis FAQs
It examines various related asset classes, including stocks, bonds, commodities, and currencies. The analysis is carried out to help identify the strengths or weaknesses of the asset type under consideration.
It was developed by financial market analyst John Murphy in his book, "Trading with Intermarket Analysis." He claims traders can gain from examining the connections between various asset types.
It can give insight into how financial marketplaces will develop in the future by finding the correlations between different asset classes. These correlations can be either positive, negative, or zero.
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