- The Bedrock: Understanding the Four Major Asset Classes
- John Murphy's Core Principles: The Intermarket Tenets
- 1. The Inverse Relationship Between Commodities and Bonds
- 2. The Generally Direct Relationship Between Bonds and Stocks
Intermarket analysis is the foundational discipline of viewing financial markets not as isolated islands, but as a deeply interconnected global system. It operates on the core principle that no asset class—be it stocks, bonds, currencies, or commodities—moves in a vacuum. Just as a ripple from a stone spreads across an entire pond, a significant move in one market inevitably sends waves through all the others. For traders and investors accustomed to focusing intensely on a single chart, a single company’s earnings, or a single economic report, embracing this holistic perspective is like switching from a magnifying glass to a panoramic satellite view. It provides context, reveals hidden strengths and weaknesses, and uncovers powerful insights that a siloed approach could never hope to detect. This methodology is not about a magical crystal ball; it is a logical framework for understanding the flow of capital around the world, driven by the ceaseless tides of economic growth, inflation, and investor sentiment. By learning to decipher the language spoken between these markets, one can move from simply reacting to price movements to anticipating them.
The modern popularization of this field owes a great deal to John Murphy, a financial markets analyst who codified the key relationships into a set of understandable principles. Before his work, many of these connections were understood intuitively by seasoned traders, but they were not part of the mainstream technical analysis toolkit. Murphy demonstrated through clear historical charting that the four major asset classes are intrinsically linked in a predictable, cyclical dance. Mastering this discipline transforms an investor from a specialist into a generalist, a strategist who understands the entire battlefield rather than just a single skirmish. In today’s highly globalized and algorithm-driven world, where news from a factory in China can impact a tech stock in California within seconds, this comprehensive view is no longer a luxury for hedge fund managers; it is an essential tool for survival and success for anyone serious about navigating the financial landscape.
The Bedrock: Understanding the Four Major Asset Classes
Before delving into the intricate web of relationships, it is crucial to have a firm grasp of the four primary asset classes that form the pillars of intermarket analysis. Each class represents a different facet of the global economy and has a distinct personality, reacting differently to economic stimuli.
1. Equities (Stocks): Stocks represent ownership in a publicly-traded company. They are considered “risk-on” assets because their value is primarily driven by expectations of future corporate earnings and economic growth. When investors are optimistic about the future, they buy stocks, anticipating that a growing economy will lead to higher profits and, consequently, higher stock prices. Conversely, when fear and uncertainty prevail, investors sell stocks, fearing that an economic slowdown will erode corporate earnings. Major stock indices like the S&P 500, NASDAQ, and FTSE 100 serve as barometers for the health of the broader economy and investor sentiment.
2. Bonds (Fixed Income): Bonds are essentially loans made to a government or a corporation, which pays the bondholder periodic interest (the coupon) and repays the principal at a future date (maturity). Government bonds, particularly those issued by stable countries like the United States (Treasuries), are considered “safe-haven” or “risk-off” assets. When investors are fearful, they often flee the perceived risk of stocks and buy government bonds for their relative safety and guaranteed payments. The relationship between bond prices and their yields is inverse: as demand for bonds rises, their prices go up, and their yields (the effective interest rate) go down. This is a critical concept in intermarket analysis.
3. Commodities: This is a broad category of raw materials and agricultural products. For the purpose of intermarket analysis, we primarily focus on key industrial and precious metals, as well as energy.
Industrial Commodities: Assets like crude oil and copper are highly sensitive to the global business cycle. Increased manufacturing and construction activity drives up demand for these materials, pushing their prices higher. Copper, in particular, is often nicknamed “Dr. Copper” because its price action is seen as having a Ph.D. in economics, often predicting economic turning points.
Precious Metals: Gold and silver have a dual nature. They have industrial uses, but they are also seen as monetary assets and safe havens. Gold, in particular, is often purchased as a hedge against inflation and currency debasement. It tends to perform well during times of economic uncertainty and when real interest rates are low or negative.
4. Currencies (Forex): The foreign exchange market is the largest and most liquid market in the world. Currency values are influenced by a multitude of factors, including interest rate differentials, economic growth, trade balances, and capital flows. The U.S. Dollar (USD) holds a special place as the world’s primary reserve currency. This means that many international transactions and major commodities (like oil) are priced in dollars. Consequently, the strength or weakness of the U.S. Dollar has a profound and far-reaching impact on all other asset classes, acting as a central pivot in the global financial system.
John Murphy’s Core Principles: The Intermarket Tenets
John Murphy’s work laid out a series of foundational relationships that act as a starting point for any student of intermarket analysis. While these relationships can and do temporarily diverge, they represent the logical, long-term economic connections that typically govern the flow of capital. Understanding the “why” behind each one is key.
1. The Inverse Relationship Between Commodities and Bonds
This is arguably the most fundamental relationship. Generally, commodity prices and bond prices move in opposite directions.
The Logic: Rising commodity prices are inflationary. When the cost of raw materials like oil, copper, and wheat goes up, it costs more for companies to produce goods. This higher cost is eventually passed on to consumers in the form of higher prices, leading to a rise in the Consumer Price Index (CPI) and other inflation metrics. Central banks, whose primary mandate is often to control inflation, react to rising inflation by raising interest rates. Higher interest rates make existing bonds, with their lower fixed-coupon payments, less attractive. Consequently, the prices of these existing bonds fall to bring their yield in line with the new, higher rates.
In Practice: If you observe a strong, sustained rally in the Commodity Research Bureau (CRB) Index, you should anticipate that bond prices (as represented by Treasury futures or a bond ETF like TLT) will likely come under pressure. This is a classic “inflationary growth” signal. Conversely, a sharp drop in commodity prices is disinflationary or even deflationary. This reduces the pressure on central banks to raise rates and may even prompt them to cut rates to stimulate the economy. Lower interest rates make existing bonds more attractive, causing their prices to rise. This is a classic “economic slowdown” signal.
