Intermarket Analysis

1. All financial markets are interconnected, both domestically and globally

No market moves in isolation

Global linkages. The four main market groups - stocks, bonds, commodities, and currencies - are all interrelated. A change in one market often impacts the others. For example:

• Rising commodity prices often lead to higher interest rates and lower bond prices
• A falling dollar typically boosts commodity prices and emerging market returns
• Global stock markets tend to move together, especially during major declines

This interconnectedness extends beyond borders. Events in one country or region can quickly ripple through global markets. The 1997 Asian currency crisis, for instance, impacted markets worldwide.

2. Commodity prices and bond yields typically trend in the same direction

Rising commodity prices usually produce lower bond prices and higher bond yields

Inflation expectations. Commodity prices are seen as a barometer of inflation pressures. When commodity prices rise, it often signals increasing inflation, which erodes the value of fixed-income investments like bonds. As a result:

• Bond yields tend to rise (and bond prices fall) when commodity prices increase
• Bond yields tend to fall (and bond prices rise) when commodity prices decrease

The relationship is not always immediate or perfect, but it is a key intermarket principle to monitor. Industrial commodities like copper are especially important to watch as leading indicators for bonds and the economy.

3. Bonds usually lead stocks at major turning points in the economic cycle

Bonds peak before stocks and bottom before stocks

Economic foresight. The bond market is considered to have better foresight about economic conditions than the stock market. As a result:

• Bond prices often peak and yields bottom several months before stocks at major market tops
• Bond prices often bottom and yields peak several months before stocks at major market bottoms

This makes the bond market an important leading indicator for the stock market and economy. For example, the bond market peaked in 1987 several months before the stock market crash. Similarly, bonds bottomed in 2000 before stocks as the tech bubble burst.

4. The business cycle drives sector rotation within the stock market

Different market sectors do better at different stages of the business cycle

Cyclical shifts. As the economy moves through expansion and contraction, different stock market sectors tend to outperform:

• Early expansion: Consumer cyclicals, technology, transportation
• Mid expansion: Capital goods, basic materials
• Late expansion: Energy, materials, industrials
• Early contraction: Consumer staples, healthcare, utilities
• Late contraction: Financials, consumer cyclicals

Understanding where we are in the business cycle can help identify which sectors are likely to outperform. Relative strength analysis of sectors can also provide clues about the state of the economic cycle.

5. Real estate and housing are interest rate-sensitive, countercyclical assets

Housing and real estate are tied very closely to the direction of interest rates

Low rate beneficiary. Real estate tends to perform well when interest rates are falling, which often occurs during economic slowdowns. Key points:

• Lower mortgage rates increase housing affordability and demand
• REITs benefit from lower borrowing costs and often outperform when rates fall
• Housing can provide portfolio diversification when stocks are weak

However, the relationship is not always consistent. Periods of high inflation or deflation can impact real estate differently. The sector also follows its own long-term cycle of approximately 18 years.

6. Deflation changes traditional intermarket relationships

During deflation, bond prices rise while stocks fall

Paradigm shift. In a deflationary environment, some key intermarket relationships change:

• Bonds and stocks decouple, with bonds rising while stocks fall
• Falling commodity prices become bearish for stocks rather than bullish
• Cash and high-quality bonds become preferred assets

This was seen during the Great Depression of the 1930s and again to some extent in the early 2000s as deflationary pressures emerged. Recognizing deflationary conditions is crucial for proper asset allocation.

7. Ratio analysis helps identify relative strength between asset classes

A rising ratio line shows that the numerator is the stronger market

Comparative performance. Ratio charts divide one asset by another to show relative strength:

• Rising CRB/stock ratio = commodities outperforming stocks
• Rising bond/stock ratio = bonds outperforming stocks
• Rising gold/currency ratio = gold outperforming that currency

These ratios can identify major trend changes between asset classes and help guide asset allocation decisions. For example, the CRB/stock ratio bottoming in 2000 signaled a major shift from paper assets to hard assets.

8. Long-term economic cycles impact financial market trends

Each asset class has its "day in the sun"

Secular shifts. Several long-term cycles influence market behavior:

• Kondratieff Wave: ~55 year cycle in economic activity and inflation
• 18-year real estate cycle
• 4-year business cycle

These cycles help explain multi-year trends in different asset classes. For instance, the Kondratieff winter phase is associated with falling commodity prices and deflation, similar to conditions in the 1930s and early 2000s.

Understanding where we are in these long-term cycles can provide valuable context for shorter-term trends and asset allocation decisions.

9. Global diversification benefits diminish during major bear markets

World markets usually fall together at such times

Correlation convergence. While global diversification is generally beneficial, its advantages can decrease significantly during severe market downturns:

• In the 1987 crash, 1998 Asian crisis, and 2000-2002 bear market, global stocks fell in unison
• Emerging markets often experience even steeper declines than developed markets
• Currency fluctuations can exacerbate losses for foreign investments

This doesn't negate the long-term benefits of global diversification, but investors should be aware that it may not provide as much protection in extreme market conditions.

10. Currency trends significantly influence commodity prices and global returns

A falling dollar is bullish for commodities

Exchange rate impact. Currency movements have far-reaching effects:

• A falling dollar typically boosts commodity prices (priced in dollars)
• Weaker currencies benefit export-driven economies
• Currency trends impact the relative attractiveness of foreign investments

For example, the dollar's decline in 2002-2003 contributed to rising commodity prices and strong performance in emerging markets. Understanding currency trends is crucial for global investors and commodity traders.

Last updated: April 19, 2025