Intermarket Relationships

How intermarket technical analysis can add value to your investment process.

What occurs in one market, most likely, impacts what occurs in other markets.

This is the base assumption of intermarket technical analysis. Paying attention to intermarket relationships can provide valuable insights to investors of all time-frames. Whether it’s analyzing correlations between US and European equities, or evaluating the behavior of interest rates versus major world currencies, an intermarket approach can add another layer of objectivity to your investment analysis.

Let’s begin with a review of 3 major asset classes: Stocks, Bonds and Commodities. The cycle at a market top will typically play out like this:

• Commodities rally

• Bonds will peak as interest rates rise

• Stocks peak

• Commodities peak last

The cycle at a market bottom will typically play out like this:

• Commodities peak

• Bonds bottom as interest rates fall

• Stocks Bottom

• Commodities bottom last

A bond market bottom will coincide with a commodity market peak. Below is a chart of a well followed commodity index overlayed with T-Bonds set on an inverted scale. The rolling 52-week correlation coefficient is -0.90. Hence when commodities peak, we typically see bonds bottom!

It was noted above that bonds typically peak/bottom before stocks. This timeframe can range from a few months to a few years, but the evidence is there. Bonds peak/bottom before stocks in a typical market cycle.

Below is a chart of the S&P 500 Index (stocks) overlayed with T-bonds shifted forward 2 years. This chart is used to illustrate the lead time bonds have over stocks. It is not meant to be predictive in any form.

Given the above information, where do we think we are in the current market cycle? Are we waiting for commodities to peak and bonds to bottom? I’d like to think so. Investors will feel much better about their stock portfolios when we see confirmation from the commodity and bond markets.

If you’ve made it this far into the post, you may have noticed that the driving force behind these cycles are interest rates. Forecasting interest rates is one of the most difficult tasks to execute. I don’t like to pretend I have a specialization in this field. I don’t. But I can share with you the relationship between interest rates and the US Dollar.

Interest rates and the US Dollar tend to display a circular relationship. Below is a chart of the US 5-year Government Bond Yield overlayed with the US Dollar Index.

Let’s breakdown what I mean by circular relationship.

1. Correlated regime

2. USD Down, Rates Up

3. Rates Up, USD Up

4. USD Up, Rates Down

5. Rates Down, USD Down

In 2021, did we begin the circular process all over again? The evidence thus far, points to yes.

• USD Down, Rates Up (#2)

• Rates Up, USD Up (#3)

So what is left to complete the cycle?

• USD Up, Rates Down (#4)

• Rates Down, USD Down (#5)

Rates down? You don’t say, that would coincide with a bottom in bonds. As of the date of this post, there is insufficient evidence to support a legitimate bottom in bonds or peak in the commodity market. However, intermarket technicians are paying close attention to these markets. When the bottom in bonds is in, I’d assume you’ll hear your favorite stock investors getting louder and louder calling for a stock market bottom.

That’s enough out of me.

SM

This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. All indices are unmanaged and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results. Please contact your financial professional for more information specific to your situation.