lecture 12: intermarket analysis

Question 1

The basic premise of intermarket analysis

Answer 1

all financial markets are linked in some way

Although the relationships may shift on occasion, they are always present in one form or another

Question 2

why are all financial markets are linked?

Answer 2

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

Question 3

The 4 market groups that we will discuss

Answer 3

currencies

commodities

bonds

stocks

Question 4

Stock v.s. Bond Cycle

all the phases

Answer 4

Phase 1: Bonds up, stocks down

Phase 2: Bonds up, stocks up

Phase 3: Bonds down, stocks up

Phase 4: Bonds down, stocks down

Question 5

Phase 1: Bonds up, stocks down

Answer 5

When the economy is weak, bonds usually do better than stocks for a while because the earnings environment is poor

Question 6

Phase 2: Bonds up, stocks up

Answer 6

Then stocks start to move up because lower interest rates get investors to buy in anticipation of an improved economy and therefore, better earnings.

Question 7

Phase 3: Bonds down, stocks up

Answer 7

Later the economy is actually strengthening, with increased credit demand and improved pricing and earnings are rising

Question 8

Phase 4: Bonds down, stocks down

Answer 8

Eventually, higher interest rates cause investors to be concerned that economic activity will slow down and therefore, earnings will soon weaken

Question 9

When looking at commodities, why do we always look first to gold?

what is a more representative benchmark to use?

Answer 9

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

Question 10

relationship between bond prices and commodities

Answer 10

inverse relationship

Question 11

Rising commodity prices (as measured by the CRB index) mean what?

Answer 11

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

Question 12

A ↑ USD means what?

Answer 12

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

Question 13

A ↑ in the CRB index means what?

Answer 13

generally bad for the bond and stock markets as it signals increased inflation and possible increases in interest rates

Question 14

that the inverse relationship between commodities and bonds & stocks holds true during inflationary & disinflationary periods, but not necessarily during deflationary periods

why?

Answer 14

In a deflationary environment, decreasing commodities are generally positive for bonds, but not necessarily good for stocks

Question 15

Disinflationary scenario: Commodities ↓

Answer 15

Bonds ↑
Stocks ↑

Question 16

Deflationary scenario: Commodities ↓

Answer 16

Bonds ↑
Stocks ↓

Question 17

When USD ↓, multinational earnings ↑ because

Answer 17

↓ USD means that US goods are more attractive overseas

Products sold overseas (example, Europe) will have to be converted back into a weaker USD which in turn results in a bigger bottom line.

Question 18

When the USD ↓, drug stocks tend to do well, because

Answer 18

Most of their sales are derived overseas. So when the market is weak, they tend to outperform the other sectors as a result.

This goes beyond the fact that they are defensive in nature