What Is Intermarket Analysis?
Intermarket analysis is a method within financial market analysis that examines the relationships and correlations between different asset classes and financial markets to forecast future price movements. It operates on the premise that no single market exists in isolation, and the performance of one market often influences or is influenced by others. By observing how equity markets, bond markets, commodity markets, and currency markets interact, analysts aim to gain a more holistic understanding of the overall market trends and the underlying economic forces at play. This approach provides a broader perspective than analyzing individual markets in isolation, recognizing the interconnectedness of the global economy.
History and Origin
The concept of intermarket analysis gained prominence largely through the work of technical analyst John J. Murphy, particularly with his foundational book, "Intermarket Technical Analysis: Trading Strategies for the Global Stock, Bond, Commodity, and Currency Markets," published in 1991. Murphy posited that due to increasing globalization and financial integration, the traditional practice of analyzing markets in isolation was becoming less effective. He argued that shifts in one market often precede or coincide with significant movements in another, making the study of their relationships crucial for informed decision-making. His subsequent works, such as "Trading with Intermarket Analysis," further detailed visual approaches to understanding these dynamics, emphasizing that all markets are interrelated and influence each other.4
Key Takeaways
- Intermarket analysis studies the relationships and correlation between different asset classes, including stocks, bonds, commodities, and currencies.
- It operates on the principle that financial markets are interconnected, and events in one market can affect others.
- This analytical approach provides insights into the broader economic landscape and can help forecast potential shifts in market dynamics.
- Understanding intermarket relationships can aid in asset allocation, risk management, and identifying leading indicators.
- John J. Murphy is widely credited with popularizing and formalizing the methodology of intermarket analysis.
Interpreting Intermarket Analysis
Interpreting intermarket analysis involves recognizing typical relationships and divergences between markets. For instance, bond prices and interest rates often move inversely, and rising bond prices (falling yields) can signal investor concern about economic growth, potentially leading to a flight to safety from equity markets. Similarly, rising commodity markets can indicate inflationary pressures, which may negatively impact bond prices and eventually lead central banks to raise interest rates, influencing other asset classes.
Another key aspect is the relationship between the U.S. Dollar and commodities. A stronger dollar often makes dollar-denominated commodities more expensive for international buyers, potentially leading to lower commodity prices, and vice versa. Analysts continuously monitor these interwoven movements to identify early signals of shifts in the economic or market cycle, helping to anticipate broad market direction rather than focusing solely on individual stock movements or technical indicators within a single market.
Hypothetical Example
Consider a hypothetical scenario where an analyst is using intermarket analysis to assess the outlook for the stock market. They observe a significant decline in bond markets, particularly long-term government bonds, suggesting that bond yields are rising. Historically, rising bond yields can make fixed-income investments more attractive relative to stocks, or signal increasing inflation expectations which can be detrimental to stock valuations.
Simultaneously, the analyst notes a strong rally in commodity markets, especially industrial metals and energy, indicating robust demand and potential inflationary pressures. This combination of rising bond yields and surging commodity prices might suggest that the market anticipates stronger economic growth but also higher inflation, potentially prompting the central bank to tighten monetary policy. Such a macroeconomic shift could put downward pressure on equity markets, as higher interest rates increase borrowing costs for companies and reduce the present value of future earnings. By observing these interconnected movements, the analyst gains a more comprehensive view than by just looking at stock charts in isolation.
Practical Applications
Intermarket analysis offers several practical applications for investors and traders. It is widely used in portfolio management to inform asset allocation decisions, allowing investors to dynamically shift capital between different asset classes based on perceived intermarket relationships and the prevailing economic cycles. For instance, if bonds are signaling a slowdown, an investor might reduce equity exposure and increase bond holdings.
Furthermore, intermarket analysis assists in confirming trends and identifying reversals. A strong upward trend in stocks might be viewed with caution if bond yields are also rising sharply, indicating potential inflationary headwinds or an impending shift in monetary policy. Conversely, a bottom in commodity markets or a peak in the U.S. Dollar could signal a potential turning point for global equities. For example, the relationship between stocks and bonds is a very important link in intermarket analysis, with bond prices and commodity prices typically trending in opposite directions.3 News and economic data, such as inflation figures and central bank policy decisions (like those from the Federal Reserve), are closely watched as they directly impact these intermarket dynamics across various currency markets and other asset classes.2
Limitations and Criticisms
While intermarket analysis provides valuable insights into the interconnectedness of global financial markets, it is not without limitations. The correlation between different asset classes can change over time due to various factors, including evolving economic conditions, geopolitical events, and shifts in investor sentiment. A relationship that held true for decades may weaken or even reverse, making it challenging to rely solely on historical patterns. The global economy is subject to numerous complex interactions and uncertainties, which are regularly analyzed in publications like the World Economic Outlook.1
Another criticism is that identifying leading or lagging indicators can be subjective and prone to hindsight bias. What appears to be a clear lead-lag relationship after the fact may not be as evident in real-time. Additionally, unexpected events, often referred to as "black swans," can disrupt established intermarket relationships and lead to erroneous conclusions. Consequently, intermarket analysis should ideally be used in conjunction with other analytical methods, such as fundamental analysis or a deeper dive into specific technical indicators, rather than as a standalone forecasting tool.
Intermarket Analysis vs. Technical Analysis
Intermarket analysis is often considered a specialized branch or an advanced application of technical analysis. While both disciplines primarily study past market data—like price and volume—to forecast future movements, their scope differs.
| Feature | Intermarket Analysis | Technical Analysis (General) |
|---|---|---|
| Primary Focus | Relationships and correlation between different asset classes and markets. | Price patterns, volume, and technical indicators within a single market or security. |
| Scope of View | Holistic; studies how global markets and economies influence each other. | Narrower; focuses on individual securities, sectors, or a single market. |
| Goal | Understand broad market direction, economic cycles, and relative strength across markets. | Identify trading opportunities, predict specific price movements, and define support and resistance levels. |
| Key Question Asked | "How are bonds affecting stocks?" or "What does commodity strength imply for currencies?" | "Is this stock likely to go up or down based on its chart?" |
The confusion arises because intermarket analysis uses many of the charting tools and principles of traditional technical analysis (e.g., trend lines, moving averages) but applies them across multiple markets simultaneously, looking for divergences and confirmations that reveal underlying economic forces.
FAQs
What are the main asset classes typically considered in intermarket analysis?
The primary asset classes often analyzed in intermarket analysis are stocks (equities), bonds (fixed income), commodities, and currencies. These four groups are believed to have significant and observable relationships that can provide insights into the broader financial landscape.
How does intermarket analysis help with diversification?
By understanding the correlation between different markets, intermarket analysis can help investors build more resilient portfolios. If certain asset classes tend to move in opposite directions, combining them can help with diversification by reducing overall portfolio volatility.
Is intermarket analysis only for short-term traders?
No, intermarket analysis is beneficial for both short-term traders and long-term investors. Traders might use it to identify short-term divergences for speculative opportunities, while long-term investors can apply it to inform strategic asset allocation decisions and manage risk management based on the overall health of the global economy.