Dear colleagues. Among the fundamental events of the economic calendar this week, one can highlight the publication of unclear data on the state of the German economy, and although data on the dynamics of GDP of the largest economy in the eurozone remained unchanged, showing annual growth of 2.1%, data on business activity and the sentiment of German market participants did not shone with optimism. Moreover, the data showed a sharp decline, which happened for the first time in many months. The index of business activity in the manufacturing sector of this country decreased to 50.2, i.e. actually to a state of stagnation, despite the fact that analysts expected it at the level of 52.0. The situation was even more depressing in an assessment of the business climate in Germany conducted by the IFO Institute. The business climate index fell sharply, suffering its biggest decline since November 2008. Also, for the first time in the last few years, the Ifo-Business Cycle index in manufacturing and trade moved into the “Downswing” state (Fig. 1), which is an alarming signal for the entire system. If German industry declines, the eurozone's economic performance will plunge into recession, squashing any hopes of recovery, further increasing centrifugal sentiment in Europe.

This situation plays into the hands of ECB Chairman Mario Draghi, who next week is going to change the policy of the institution he leads towards further easing of monetary conditions, which will play against the European currency in the medium and long term. However, the only thing that the ECB has managed to do so far during the year of quantitative easing policy is to turn the euro into a funding currency that rises and falls in contrast to the American stock market. However, I am almost sure that it is precisely this undeclared task of maintaining the American market that the ECB is solving, but naturally no one says this out loud. All other successes of the regulator in the field of monetary easing are very controversial: - inflation has not been started, unemployment is consistently above 10 percent, and the vaunted stress tests of European systemically important banks have largely turned out to be a sham. Otherwise, it is not very clear how Deutsche Bank (DE: DBKGn) was able to create such a huge position in derivatives, threatening the collapse of the entire global financial system.

Money market analysis.
The situation in the money market continues to remain without significant changes, in the sense that in percentage terms the US dollar is becoming more expensive, and the euro is becoming cheaper, which is caused by the policy of central banks not pursuing counter exchange rates. At the same time, the Fed’s policy, despite the increase in interest rates, remains largely accommodative, including through reverse repo operations. For example, the Fed’s balance sheet has not changed over the past year and is at $4.5 trillion, despite the start of a cycle of increasing interest rates. At the same time, rates on the money market in US dollars continue to rise (Fig. 2).

At the same time, in the eurozone money market, yields continue to decline in the negative zone. Auctions of French treasury bills, held at the beginning of this week, again showed a decrease in yields and an increase in prices, although insignificant (Fig. 3). So the couple EUR/USD despite the current decline in value, the currency still remains overbought in relation to the money market, which is primarily due to the decline in the American stock market, which cannot recover. It is this decline that lurks the main danger for the US dollar in the short term, and it is this decline that acts as support for the euro exchange rate. However, if the ECB still decides to lower the deposit rate to 0.4%, as informed analysts suggest, this will lead to a further drop in bill yields and a decline in the EUR/USD rate to the lower limit of the range of 1.05-1.15.

Product market analysis
The agreements reached between Russia and Saudi Arabia, to which a number of other countries joined, although with reservations, kept the commodity market afloat, preventing it from hitting the bottom in a second attempt. Currently, the consensus forecast of analysts and central banks for the price of oil by the end of 2016 assumes the grade level Brent about $40 per barrel. This is the price expected by US EIA analysts, and the same price was announced by the Bank of England in its February inflation forecast. Although, perhaps, an allowance should be made for the possibility that they are copying off each other’s forecasts without bothering with their own calculations. It should be taken into account that the price has already been below 40 during the first two months of this year. Now it is extremely unlikely that the price of oil will be able to remain below the level of $30 per barrel for a long time, but we cannot exclude the possibility that by the end of the year the price may be lower than the predicted level.

From the point of view of intermarket analysis, what we are currently seeing in the interaction of FOREX and the commodity market is the alignment of markets relative to each other, when the price of the euro decreases simultaneously with the increase in the price of oil. Let me remind readers that last week a fundamental signal of intermarket divergence formed between the euro and oil. The simultaneous convergence of markets should ultimately lead to the signal leveling out and the fundamental connection being restored. If the commodity market does not find drivers for growth in the near future, the EUR/USD exchange rate will continue to remain under pressure from commodity prices, which, together with the money market, will fundamentally reduce its value in relation to higher-yielding currencies.

As can be seen from the TR/CC-CRB Index chart (Fig. 4), despite the fact that the commodity index tested the level of 155 twice and was unable to overcome it, there is no talk of a market recovery yet, but there is hope that the commodity market reached the bottom, still there. Alternatively, we can assume the formation of a long range within the existing limits. The current cost of goods against the backdrop of the EUR/USD rate, which is in the range of 1.05 - 1.15, firstly, provides the commodity market with the opportunity to recover, at least to the values ​​of autumn 2015, and secondly, it assumes a long-term and medium-term decline in the EUR/USD rate , and the growth of the US dollar.

US stock market analysis
The dynamics of the US stock market remains the main factor influencing the euro exchange rate and putting pressure on the dollar exchange rate. At the same time, the main beneficiary of the fall in the stock market is still the Japanese yen, which has strengthened to 111, but the European currency also has its dividends from the fall in the stock market. Index cancel S&P500 from the level of 1950, as well as its location below the level of the 50-day and 200-day average line, clearly suggest a further decline and a possible re-test of the level of 1800 (Fig. 5). If such a decline does occur and the stock market does not return to attempting to recover above 1950 soon, then in the short term this should lead to a rise in the EUR/USD and a decline in the US dollar, which will occur despite the above pressures from interest rates and commodity prices. The prospect of a decline in the US stock market is also confirmed by the dynamics of the VIX volatility index, which has begun to rise again, which together implies a 65% probability of a decline in the stock market in the next few sessions, which means a process of revaluation of the European currency.

Based on the above and in accordance with the intermarket analysis of the situation, we can assume that before the ECB meeting, which will take place next week, the EUR/USD rate will most likely make another attempt to grow, caused by the sale of the US stock market. Going forward, the euro will come under pressure from ECB policy, rising interest rate potential in the US dollar, as well as low commodity prices. The assumption of a fall in the stock market can also be considered in the context of a possible short-term decline in high-yielding commodity currencies: - Australian and New Zealand dollars, which, thanks to the recovery of the stock and commodity markets, as well as rising prices gold, in the last week and a half, have made significant progress and actually won back their decline. In the Canadian dollar the situation is somewhat different from the above currencies, because... with a very high degree of probability it will follow not the stock market, but the price of oil. The dynamics of these assets, in the current situation, are largely decoupled from each other, which is caused by the large speculative component in the stock market.

Gleb Kabanov - analyst at FX Bazooka

Ifo Business Climate Germany. Results of the Ifo Business Survey for February 2016
Credit and Liquidity Programs and the Balance Sheet http://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm

They don’t tell beginners about this and try not to write about it in training courses. A trader who, in addition to technical and fundamental analysis, can also perform intermarket analysis has a much greater chance of profit, and therefore is not profitable for the broker and does not need paid advice and signals. He is quite capable of fighting on his own in any market conditions.

Every trader comes to understand the financial market as an interconnected system, but how much time and money it will take depends on individual persistence and curiosity. Moreover, a Forex trader who has received a quick and, as it seems to him, easy profit, subsequently finds it very difficult to realize the fact that it is the commodity and stock markets that are leading, and the foreign exchange market will always be a slave.

The idea of ​​mutual influence of markets was expressed by the famous Jesse Livermore, but until 1987, attempts to conduct intermarket analysis were made only by fans of technical statistics. The simultaneous collapse of the bond market, the boom in the commodity market in the spring of the same year and the subsequent collapse of the stock market in the fall, proved the existence of a tight market link between the bond, stock, commodity markets and the US dollar. It was then that technical analyst John Murphy concluded that based on the general dynamics of correlated markets, it is possible to calculate the behavior of each of them separately.

The theory was confirmed in early 1990, when the American market collapsed, but before that there was a similar fall in the Japanese, English and German bond markets. Murphy interpreted this fact as a warning signal about a decline in the stock market, which soon happened: in the first quarter of 1990, the collapse of the Japanese market began, and in the summer of the same year, the rest of the major stock markets.

Main types of financial markets

Modern market analysts distinguish the stock, commodity, foreign exchange, stock, precious metals and derivatives markets. The first two have the greatest correlation and practical significance for currencies.

Stock market (Stock Market) - carries out trading operations with shares for their initial public offering (IPO) or secondary redistribution through the OTC (over-the-counter market). Today, stock exchanges are the leading regulator and indicator of the state of the economy.

The stock market “digests” a huge number of securities, so intermarket analysis evaluates the main trend using leading stock indices, such as Standard & Poor's 500, Index, Nasdaq Composite Index, FTSE 100, Nikkei. They are calculated based on the price of shares of leading companies (in a certain proportion ), included in the index, therefore, for example, the growth of the DJIA index indirectly indicates the strengthening of the US economy.

Stock indices have a direct impact on the Forex currency market, since to assess their impact on the currency quote it is enough to study the dynamics of two indices (for example, for USD/CHF - DJIA and SMI). The most accurate signals are given by situations of opposite dynamics, and with the same movement (growth or fall) it is quite difficult to assess the impact on the currency pair.

The use of basic indices to forecast currency pairs makes sense, at least for medium- and long-term transactions - the influence of the stock market on the foreign exchange market has some inertia and there is time to conduct a comprehensive assessment. At the same time, the exchange rate reflects the general state of the economy: stable - the currency is growing, bad - falling. With a stable currency, the influx of external capital into the country increases, which, among other things, has a beneficial effect on the stock market.

Commodity market (Commodities Market) - historically the primary and largest market: the movement of goods and raw materials, or so-called “exchange” goods. It is commodity exchanges that set quality standards, standard contracts, quote prices, and regulate disputes. The objects of trade are approximately 100 types of exchange commodities, the main of which are ferrous and non-ferrous metals, soft commodities (coffee, sugar, wheat, soybeans, grains and basic products), energy resources (oil, natural gas, diesel fuel, gasoline ,propane fuel oil), industrial raw materials. Traded through universal (for example, Chicago Board of Trade, Chicago Mercantile Exchange) or specialized exchanges, such as The London Metal Exchange (copper, aluminum, nickel, tin, lead, zinc, silver, plastics), New York Coffee, Sugar Exchange and cocoa, New York Cotton Exchange.

A comprehensive assessment for is also possible using the dynamics of commodity stock exchange indices. The CRB Commodity Futures Price Index is considered the most popular and accurate, although the prices of the commodities included in this index react differently to the overall economic situation, for example, copper and aluminum are especially sensitive to bond prices, and food products are most affected from natural factors.

Basic postulates of Murphy's theory

The basic principles were set out by the author in the book “Intermarket Analysis. Principles of interaction of financial markets" (it is better to read in the original, since the correctness of Russian translations leaves much to be desired), and the practical application was first described by Rick Bensignor in his "New Thinking in Technical Analysis".

Murphy argues that the nature of the interaction of the major markets: foreign exchange, commodities, bonds and stocks determines the accuracy of the price forecast. Briefly below:

• the dynamics of the US dollar is opposite to the movement of commodities (a fall in the dollar leads to an increase, and a rise - to a decrease in prices);
• the dynamics of commodities is opposite to bond prices, but coincides with the direction of interest rates;
• bond prices and stock prices most often move in the same direction with some time gap (bonds reach extremes earlier than stocks, by about 2-3 months);
• falling interest rates have a positive effect on the stock market.
• dollar growth has a positive effect specifically on American stocks and bonds, and to assess the impact on regional stock markets, a comprehensive assessment is needed;
• during periods of deflation (which is extremely rare, but nowadays it does happen!) bond prices rise and stock prices decline;
• there are no isolated markets: everything is interconnected both nationally and globally.

Financial markets are constantly changing their internal relationships, so it is imperative to monitor mutual dependencies and asset correlations based on the latest market data.

According to the scheme proposed by Murphy, intermarket analysis should begin with the current dynamics of interest rates (if any), then move on to the commodity market, primarily gold and energy resources. The main idea of ​​the theory is to see in the dynamics of financial markets events that the real economy has not yet occurred, but fundamental processes have already prepared them and are waiting for a signal. In this case, an experienced trader will have time to prepare. Theorists believe that the underlying markets can lead economic trends by 5-8 months, especially commodities, which provide leading signals about the state of inflation.

There are situations whose dynamics make it possible to assess the probability of the direction of movement of several markets: stocks/oil, bond yields/commodity prices, commodity prices/exchange rates, stock markets/bond yields, American/Asian stock markets, global inflation/deflation, etc.

Confident growth of the stock market always increases the exchange rate of its national currency, that is, it shows a favorable situation for investing, while a fall in stock indices drives currency quotes down.

In the world market, there are triple witching days and double witching days (triple or double witching day), that is, the third Friday of March, June, September and December, when index and commodity options, as well as futures contracts, expire simultaneously. These days, massive volumes are traded on the market, including shares, with the help of which large investors carry out arbitrage and hedging operations. Speculative volatility also ricochets through the foreign exchange market, violating all the laws of technical analysis, and therefore open positions must be monitored especially carefully.

Next, we will consider some trading instruments, without studying the dynamics of which there cannot be stable trading in foreign exchange assets, especially raw materials. Anyone who is lazy to carry out such regular inter-market analysis will sooner or later be punished by the market.

Oil

Oil futures have long become a protective asset against the rise of the dollar, and any news from the oil market is actively used by speculators. A decrease in the price of basic oil brands (Brent and WTI) leads to a rise in the dollar against the euro, especially at times when there is no clear trend in the market, and speculators are waiting for any factor to pump up prices and make quick profits.

An increase in the price of the main energy raw materials causes a negative correlation with the US dollar, while USD/CAD and USD/NOK will actively fall in price. Oil puts strong pressure on inflation, the dollar index and the Asian group - the yen, the aussie and the kiwi. Japan imports almost all of the oil it consumes domestically from Canada, and the sharp rise in prices leads to a weakening of the yen.

In practice, when there is a large volume of sales of American and Canadian oil, there is a huge demand for the Canadian dollar, but in general, the USD/CAD reaction lags behind the WTI oil quotes by about 30 minutes to 1 hour, which gives good chances to scalpers. Due to the fact that China is actively purchasing Canadian oil, the Canadian began to actively respond to Chinese statistics.

On the modern market, oil is the most liquid, the most “nervous” and the most “political” exchange commodity, having a direct impact on all economic and financial processes. Timely control of oil price dynamics will be both a chance to earn money and insurance against sudden losses.

Gold

From a market perspective, gold always carries a strong psychological weight, not least because most analysts consider it a leading indicator of inflation. A rise or fall in gold prices (in any exchange form!) invariably makes headlines. The dynamics of “gold” prices are closely monitored by leading regulators, including the Federal Reserve, because gold, like a litmus test, shows how correctly the country’s current and long-term monetary policy is being pursued.

Gold has historically been perceived as a protective asset in situations of economic instability and as a hedge against inflation. The asset is considered difficult to predict in short-term trading, but the dynamics in the medium term and for periods from MN1 and above are well suited to technical analysis. Like all metals, gold reacts quite stably to speculation, which makes it possible to recognize in its dynamics a leading signal for currency pairs.

Gold has the main correlations suitable for analysis with the American (as a hedge against inflation), Australian and New Zealand dollars. The price of gold futures always outpaces the movement of Asian currency pairs, meaning for those who cannot afford to trade gold, AUD/USD will be a good substitute.

In addition, large players actively invest in gold at any moment of market instability. This is why an increase in the price of gold causes such an “illogical” reaction - it lowers the exchange rate of the US dollar (if the price of gold rises, then the dollar index falls). Combining the min of gold with the max of the dollar exchange rate indicates a possible increase in inflation, the opposite situation indicates its slowdown (max of gold with the min of the dollar).

From an analytical point of view, the influence of gold on EUR/USD is complex, this pair is too politicized today. However, throughout the past year, despite active European speculation, the euro and gold have been moving synchronously, but the euro is slightly lagging, which often provides a good chance for a short-term entry.

Copper+Silver+Nikkei

Of the raw material resources that are of serious importance for intermarket analysis, it should be noted that copper is a strategically important industrial raw material, the demand for it grows in situations where the economy is expected to grow sharply or in unforeseen situations (military conflicts, natural disasters, industrial accidents). Those who actively trade AUD/USD know well how this pair can collapse in the morning (at the close of Chinese exchanges) by 1-1.5 figures just because of a sharp drop in prices for underlying copper futures.

A similar situation develops for spot silver and the USD/CAD pair, especially during periods when quarterly futures are closed - a visually small decrease in the price of silver can cause a strong speculative surge in the Canadian dollar.

Of the indices, the most interesting is the correlation between the Nikkei 225 and the Asians - the Australian and the yen. All more or less economically justified speculations are first worked out on this index and only then on currency pairs. Of course, if your own currency fundamentals do not interfere with such a movement.

And a few more comments to add to the list

From the signal of intermarket factors to the reaction of currency pairs, there is always a period of time lag. Sometimes it seems that a particular market is not moving at all, but if any basic relationships are not working at the moment, it means that something unusual is still happening in the market. For example, if commodity prices are essentially flat but the US dollar is falling, then this could be a likely bearish scenario for bonds and stocks; if the underlying indices rise sharply (for example, the DJ30 index), it means that there is a volume purchase of shares of the 30 leading enterprises, which is clearly favorable for the dollar.

A comprehensive analysis provides the trader with important and up-to-date background information. Sometimes a preliminary study of the dynamics and analytics of related assets before the release of strong news helps to better understand the market reaction at the time of publication, not to fall into speculative “collection of stops,” but to enter the market together with major players in the right, fundamentally sound direction.

For a long-term position trader, intermarket analysis helps to find significant turning points that reflect global trends.

In addition, it is the study of related markets that allows us to timely see when leading national regulators intervene in the market. The price spikes that we all see in the terminal are, as a rule, only the final series of financial interventions; attempts to forcefully stabilize the market most often begin with funds. Sudden, unfounded movements in stock markets can mean speculative purchases of shares (most often by private large investment funds or “trusted” banks at the expense of public money) with a long-range view of the “desired” reaction of the stock and foreign exchange markets.

On Forex, the real volume of transactions is not visible, but it is quite possible to get the real volume from the largest exchanges (for example, CME) for similar currency futures. Of course, on Forex, the total volume is 8-10 times higher than the futures, but the dynamics of the currency futures are identical to the currency pair, because such a future is a derivative of the base currency. It is precisely the regulatory effect of currency futures that forces currency pairs to keep their prices in a narrow, almost identical range.

Currency futures analysis includes volume and open interest data - these are the main confirming factors in the market because volume precedes the establishment of a fair price. It is worth once again making sure that there is a large volume in the direction of the leading trend: a consistent increase in open interest shows that the trend is supported by new money, a decrease most often means a gradual weakening of the trend.

And as a conclusion...

Of course, we also don’t forget about the random factor of the market price. With the introduction of e-commerce, a huge mass of unskilled players armed with basic technical knowledge entered the world market. This causes trading volumes to accumulate at mathematically predicted points, leading to spikes in speculative volatility and disruption of theoretical price models. New technologies, ambiguity and rapid change further complicate decision making.

Today, intermarket analysis is used with equal success in any financial markets, as an addition to the usual technical analysis scheme - this allows you to take into account external factors, the balance of market forces in a timely manner and correctly assess medium- and long-term prospects. Of course, you shouldn't rely only on intermarket estimates, but it is your backup rear-view mirror, which you need to look at for safe trading.

John J. Murphy

Intermarket analysis. Principles of interaction of financial markets

Intermarket Analysis: Profiting from Global Market Relationships

Published with the assistance of the International Financial Holding FIBO Group, Ltd.

Translation LLC "LF-TEAM"

Editor V. Ionov

Project Manager A. Polovnikova

Corrector O. Ilyinskaya

Computer layout S. Novikov

Cover design Creative Bureau "Howard Roark"

© Publication in Russian, translation, design. Alpina Publisher LLC, 2012

© Electronic edition. "LitRes", 2013

Murphy J.

Intermarket analysis: Principles of interaction of financial markets / John Murphy; Per. from English – M.: Alpina Publisher, 2012.

ISBN 978-5-9614-2717-2

All rights reserved. No part of the electronic copy of this book may be reproduced in any form or by any means, including posting on the Internet or corporate networks, for private or public use without the written permission of the copyright owner.

Dedicated to Anne, a great poet, and Tim, a great brother.

Acknowledgments

I thank everyone who helped produce this book: Pamela van Giessen, executive editor at Wiley, who encouraged me to take up the pen; Jennifer McDonald and Joanna Pomerantz, whose efforts made everything fall into place; Heidi Shelton and Pete Boehmer of Stockcharts.com for their excellent charting; John Carder of Topline Investment Graphics for his innovative presentation of historical charts; Tim Murphy for his help with cover design and CGI; market analysts who generously allowed their work to be used, including Ned Davies, Ken Fisher, Ian Gordon, Martin Pring and Sam Stovall. Finally, I am grateful to the Maktools family, who supported me morally throughout the writing of the book.

Introduction to Intermarket Analysis

In 1990, I completed a book entitled Intermarket Technical Analysis: Trading Strategies for the Global Stock, Bond, Commodity and Currency Markets. I wanted to show how closely financial markets are interconnected at the national and global levels. The book emphasized that technical analysts need to broaden their perspective and consider intermarket relationships. Analyzing the stock market, for example, without considering trends in the dollar, bond and commodity markets is simply incomplete. Financial markets can be used as leading indicators of other markets and sometimes as confirmatory indicators of interconnected markets. Because the premise of this book rejected the traditional focus of the technical analyst community on separate market, some doubted whether the new approach could be applied to technical analysis. Many have asked whether cross-market relationships even exist and whether they can be used in the forecasting process. The possibility of interconnection between global markets was also viewed with skepticism. How everything has changed in just a decade!

Intermarket analysis is currently considered one of the areas of technical analysis and is becoming increasingly popular. In 2002 the magazine Journal of Technical Analysis conducted a survey of members of the Association of Technical Analysts to assess the relative importance of technical disciplines in a technical analysis curriculum. Intermarket analysis ranked fifth among 14 disciplines. Over the past 10 years, the idea of ​​intermarket interaction has come a long way.

Events of the 1980s

My previous book focused on events in the 1980s, starting with collapse of commodity markets. It ended the hyperinflationary period of the 1970s, when physical assets such as commodities soared and paper assets such as bonds and stocks fell. The commodity market peak in 1980 began a 20-year deflationary trend that coincided with strong gains in the bond and stock markets. The most notable financial event of the 1980s. The stock market crash of 1987 is a textbook example of how markets interact and shows how important it is to pay attention to interconnected markets. The surge in commodity prices and collapse in bond prices in the first half of 1987 directly signaled an impending stock market decline in the second half of that year. Three years later, in 1990, when the previous book went to press, global financial markets were just beginning to react to Iraq's invasion of Kuwait in August. Gold and oil prices rose sharply and stock markets fell around the world. It is noteworthy that 13 years later (in early 2003), market analysts, in anticipation of a new war in Iraq, were actively studying the market reaction in 1990-1991. looking for parallels. History repeats itself even in the sphere of intermarket interaction.

The collapse of the Japanese bubble in 1990

The consequences of another significant event that occurred in the early 1990s are still being felt globally more than 10 years later. Then the bubble burst in the Japanese stock market. Its collapse marked the beginning of a 13-year decline in this market (which represented the world's second largest economy) and a period deflation(reducing prices for goods and services). A decade later, Western central banks turned to the Japanese deflation model in search of ways to combat the growing deflationary processes in the economies of Western countries. Some of the graphs presented in this book also support the view that deflation in Japan was a major factor communication disruptions between bonds and stocks in the United States a year later, when the rise in bond prices that began in 2000 coincided with a fall in stock prices.

Third anniversary of the 2000 market peak.

March 10, 2003 marked the third anniversary of the collapse of the Nasdaq bubble, which marked the beginning of the worst bear market in decades. The S&P 500's 50% drop was the worst since 1974. The Nasdaq's 78% loss was the largest since the stock market crash of 1929-1932. during the height of the Great Depression. Market historians had to return to the study of these two periods in order to gain some understanding of market behavior. The comparison, however, was complicated by the fact that the economic reasons were different. Stock market crash in the 1970s. was associated with rising commodity prices and hyperinflation, while the fall in stock prices in the 1930s. occurred in conditions of economic deflation. While both situations are bad for stocks, deflation is harder to counteract.

In 1998 the word deflation, which had not been heard since the 1930s, sounded again. This occurred as a result of the Asian currency crisis that gripped the world in 1997 and 1998. Within five years, deflation had spread beyond Asia and hit bond and stock markets around the world, including the United States. More than any other factor, it changed the inter-market relationships that had existed over the previous 40 years. It was these changes that made me write this book - to show what continues to work according to the old intermarket model and what does not. Intermarket analysis is based on the interactions (or relationships) between markets. However, the situation in this area is not static. The relationships between financial markets may change over time. The changes are not random; they usually have a good reason. The main reason for some of them, which began in the late 1990s, was the growing threat of deflation.

Deflationary scenario

I supplemented the new edition of the book “Technical Analysis of Financial Markets” in 1999 with a chapter on intermarket analysis, which examined historical relationships that have operated over several decades. I have also added a new section called "Deflationary Scenario". It described the collapse of Asian currency and stock markets that began in mid-1997. The sharp decline had a particularly negative impact on global commodity markets such as copper, gold and oil. For the first time in a long time, analysts were worried that the favorable era slowing inflation(when prices rise at a lower rate) will end and a period of harmful deflation(when prices for goods actually decrease). The reaction of markets to this initial threat of deflation determined the pattern of intermarket interactions over the next five years. Commodity prices fell and bond prices rose. This was nothing new - falling commodity prices usually lead to higher bond prices. What has changed is the relationship between bonds and stocks. Throughout 1998, stocks sold off across the board, with money flowing into U.S. Treasuries for safety. In other words, stocks fell while bonds rose. This was unusual and represented the largest change in the intermarket model. The slowdown in inflation (which occurred from 1981 to 1997) is bad for commodities, but good for bonds and stocks. Deflation (which began in 1998) is usually good for bonds and bad for commodities, but this time it was bad for stocks as well. In deflation, bond prices rise and interest rates fall. Lower interest rates, however, are not supporting stocks. That's why the Federal Reserve's repeated interest rate cuts in the 18 months after January 2001 failed to stem the stock market's decline from its peak in early 2000.

There are several types of stock analysis in the market. The main ones, undoubtedly, are fundamental and technical analysis.

Enterprises with already high debt loads are especially sensitive in this regard. A debt/equity ratio (D/E) exceeding 70% is already a risk factor, let alone over 100%.

Another point lies in the field of corporate finance theory. Analysts often calculate a stock's fair value using discounted cash flow (DCF) models. According to these models, expected cash flows are reduced to the present period using a discount rate. This rate depends on the risk-free return and is in the denominator in the calculations.

Accordingly, the higher the risk-free rates, the lower the estimated fair value of the shares. This situation can provoke large portfolio managers to sell shares with a confident increase in Treasury yields, as well as to revise the targets of investment houses.

Well, the most banal moment. This situation is especially dangerous for traditionally dividend-paying sectors - telecoms, energy. Everything is simple here: the higher the yield on long-term government bonds, the less interesting the earnings on dividends. It is much easier to invest in relatively risk-free assets without being exposed to the specific risks of stocks. This means that dividend securities need a drawdown to successfully compete with treasuries.

Dollar and bonds

Here the relationship between the instruments themselves is in theory negative. The higher bond yields are, the stronger the dollar should look. To assess general trends, there is the dollar index (DXY), which shows the dynamics of the “American” against a basket of world currencies.

The higher the interest rates in the US compared to the rates abroad, the more attractive the dollar is for purchases. In addition to rates as such, the US currency is affected by the state of the US economy. Again, an improving economy raises inflation expectations and therefore pushes interest rates higher.

Dynamics of assets from 1998 to 2008, monthly timeframe

Let’s not forget about geopolitical risks and other disasters. During such periods, the market moves into risk-free assets, including the dollar and Treasuries. So local rises in DXY against the backdrop of falling yields may be completely justified.

Dollar and shares

The strengthening of the dollar along with rising bond yields means tightening financial conditions, which is so dangerous for the stock market. Moreover, the rise of the US currency is not beneficial for US exporters, which account for a decent portion of US corporations in the S&P 500 index.

Dollar, bonds and commodity markets

The DXY index has a negative relationship with commodity assets, since almost all such instruments are denominated in dollars. The higher the American exchange rate, the less attractive the commodity markets. I would like to note that the CRB index is considered a classic comprehensive indicator in the commodities market.

Gold especially stands out against this background. Often, quotes of the “yellow metal” react faster to the dynamics of the dollar, ahead of other groups of commodity assets. Everything is banal, gold is considered to be a traditional insurance against inflation. The higher interest rates and the higher the dollar exchange rate, the lower the risks of inflation, which means the less attractive gold is.

You need to understand that different groups of commodity markets are characterized by specific risks and catalysts that affect supply and demand. So, tracking the dollar is not a “panacea” and the driver of all movements.

Asset dynamics for the year, daily timeframe

Business cycle analysis

Consider the long-awaited basic chain: bonds (interest rates) - dollar - commodity markets - bonds (interest rates) - stocks - ...

1) Rising interest rates (falling bonds) leads to a stronger dollar.

2) Gold begins to decline.

3) Other commodity markets (CRB index) follow gold downwards.

4) Inflationary expectations are falling. Interest rates begin to fall and bonds rise.

5) The stock market is growing.

6) Against the backdrop of falling yields, the dollar is weakening.

7) Gold begins to strengthen.

8) Following gold, other commodity markets are also strengthening.

9) Inflation expectations are rising, followed by interest rates. Bonds are falling.

10) Stocks are falling.

11) The dollar is strengthening, etc.

Thus, we have a closed cycle. An approximate diagram of the movement of instruments within the economic cycle is indicated in the diagram. Let me note that an economic downturn is characterized by a decrease in Fed interest rates, and a growth is characterized by an increase in rates.

Book by D. Murphy entitled “Intermarket technical analysis” is intended for readers who do not have professional training in the field of technical analysis. One of the main themes of the book is that absolutely all markets - commodity, currency, stock and others - are closely interconnected. Equity markets are heavily influenced by bond markets. And the price of a bond largely depends on trends in commodity markets, and those, in turn, directly depend on the state of affairs on the Forex market. The US market influences the markets of other countries, which also influence the American market. Changes in one market have consequences for all others. And all these relationships and patterns must be taken into account in technical analysis.

In his book, Murphy explains these relationships in clear language and shows practical examples of how this information can be used. The author examines in detail 4 market sectors: bond market, stock market, commodity market, Forex currency market.

According to Murphy's definition, intermarket technical analysis is the application of technical analysis to existing intermarket relationships. The book's materials are illustrated with numerous graphics. And for beginners in technical analysis, at the very end of the book there is a dictionary that deciphers the definitions of all formulations and tools found in the book.

After reading this book, you will be able to discover the latest approach to analyzing financial markets. You will see the depth of relationships between different markets and will be able to use this knowledge using the graphical analysis method described.