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Intermarket Analysis: Profiting from Global Market Relationships

Intermarket Analysis: Profiting from Global Market Relationships

by John J. Murphy

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"John Murphy has done it again. He dissects the global relationships between equities, bonds, currencies, and commodities like no one else can, and lays out an irrefutable case for intermarket analysis in plain English. This book is a must-read for all serious traders."
-Louis B. Mendelsohn, creator of VantagePoint



"John Murphy has done it again. He dissects the global relationships between equities, bonds, currencies, and commodities like no one else can, and lays out an irrefutable case for intermarket analysis in plain English. This book is a must-read for all serious traders."
-Louis B. Mendelsohn, creator of VantagePoint Intermarket Analysis software

"John Murphy's Intermarket Analysis should be on the desk of every trader and investor if they want to be positioned in the right markets at the right time."
-Thom Hartle, President, Market Analytics, Inc. (

"This book is full of valuable information. As a daily practitioner of intermarket analysis, I thought I knew most aspects of this invaluable subject, but this book gave me several new ideas. I thoroughly recommend it for beginners and professionals."
-Martin Pring, President of and editor of the Intermarket Review Newsletter

"Mr. Murphy's Intermarket Analysis is truly the most efficient and unambiguous way to define economic and fundamental relationships as they unfold in the market. It cuts through all of the conflicting economic news/views expressed each day to provide a clear picture of the 'here and now' in the global marketplace."
-Dennis Hynes, Managing Director, R. W. Pressprich

"Master Murphy is back with the quintessential look at intermarket analysis. The complex relationships among financial instruments have never been more important, and this book brings it all into focus. This is an essential read for all investors."
-Andrew Bekoff, Technical Strategist, VDM NYSE Specialists

"John Murphy is a legend in technical analysis, and a master at explaining precisely how the major markets impact each other. This updated version provides even more lessons from the past, plus fresh insights on current market trends."
-Price Headley,, author of Big Trends in Trading

Editorial Reviews

From the Publisher
“…valuable reading for the professional because it provides a detailed overview of a subject that still attracts relatively little attention...” (The Technical Analyst, April 2004)

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Wiley Trading , #115
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Intermarket Analysis

Profiting from Global Market Relationships
By John Murphy

John Wiley & Sons

ISBN: 0-471-02329-9

Chapter One

A Review of the 1980s

To fully understand the dramatic turns in the financial markets that started in 1980, it's necessary to know something about the 1970s. That decade witnessed a virtual explosion in commodity markets, which led to spiraling inflation and rising interest rates. From 1971 to 1980, the Commodity Research Bureau (CRB) Index-which is a basket of commodity prices-appreciated in value by 250 percent. Bond yields rose by 150 percent during the same period and, as a result, bond prices declined. Figure 1.1 shows the close correlation between the CRB Index and the yield on 10-year Treasuries between 1973 and 1987. Long-term rates rose with commodities during the inflationary 1970s and fell with them during the disinflationary 1980s.

The 1970s were not good for stocks, either. The Dow Jones Industrial Average started the decade near 1,000 and ended the decade at about the same level. In the middle of that 10-year period of stock market stagnation, the Dow lost almost half its value. The 1970s were a decade for tangible assets; paper assets were out of favor. By the end of the decade, gold prices had soared to over $700 per ounce. A weak dollar during that period also contributed to the upward spiral in gold and other commodity prices-as well as the relative weakness in bonds and stocks. All this started tochange in 1980, when the bubble burst in the commodity markets. Figure 1.2 is a ratio of the Dow Industrials divided by the gold market. The plunge in this ratio during the 1970s reflected the superior performance by gold and other hard assets in that inflationary decade. The ratio bottomed in 1980 after gold peaked. The Dow then bottomed in 1982.


In late 1980, the bubble in commodity prices suddenly burst. The CRB Index started to fall from a record level of 330 points-and began a 20-year decline during which it lost half of its value. During these same 20 years, gold prices fell from $700 to $250, losing over 60 percent of their value. (It was not until after the stock market peak in 2000 that gold prices started to show signs that their twenty-year bear hibernation had ended.) The 1980 peak in commodity markets ended the inflationary spiral of the 1970s and ushered in an era of falling inflation (or disinflation) that lasted until the end of the twentieth century. Figure 1.3 shows the dramatic rally in a number of commodity indexes during the 1970s and the major peak that occurred in 1980. Commodity prices declined for the next 20 years. Another financial market made a big turn in 1980 that had a lot to do with the big peak in commodities: the U.S. dollar.


The U.S. dollar hit a major bottom in 1980 and doubled in price over the next five years. One of the key intermarket relationships involved is the inverse relationship between commodity prices and the U.S. dollar. A falling dollar is inflationary in nature, and usually coincides with rising commodity prices (especially gold). A rising dollar has the opposite effect and is bearish for commodities and gold. This is why the significant upturn in the U.S. currency in 1980 was such an important ingredient in the historic turn from hyperinflation to disinflation that characterized the next 20 years. (Starting in year 2002, a major decline in the U.S. dollar contributed to a major upturn in gold and other commodities.)


Another key intermarket relationship has to do with bond and commodity prices. They trend in opposite directions. Rising commodity prices (like those seen in the 1970s) signal rising inflation pressure, which puts upward pressure on interest rates and downward pressure on bond prices. (Bond prices and bond yields trend in opposite directions.) Commodity prices often change direction ahead of bonds, which also makes them leading indicators of bonds at important turning points. At the start of the 1980s, it took a year for the drop in commodities to push the bond market higher.

During the second half of 1981, bond yields peaked near 15 percent. They fell to half that level (7 percent) within five years, which caused a major upturn in bond prices. The tide had turned. The stock market, which had been held back for a decade by rising interest rates, soon got an enormous boost from falling bond yields (and rising bond prices).


During the summer of 1982, within a year of the bond market bottom, the biggest bull run in stock market history started-and lasted for almost two decades. The fact that the bond market bottomed ahead of stocks is also part of the normal pattern. The bond market has a history of turning ahead of stocks and is therefore viewed as a leading indicator of the stock market. The intermarket scenario had completely reversed itself at the start of the 1980s. Hard assets (like commodities) were in decline, while paper assets (bonds and stocks) were back in favor.

This turning point was one of the clearest examples of how intermarket relationships play out. Notice that four different market groups were involved: currencies, commodities, bonds, and stocks. All four played a major role as the inflationary 1970s ended and the disinflationary 1980s began. Let's review the groundrules for how the financial markets normally interact with each other, which form the basis for our intermarket work.


Intermarket analysis involves the simultaneous analysis of the four financial markets-currencies, commodities, bonds, and stocks. It is how these four markets interact with each other that gives them their predictive value. Here is how they interrelate:

The U.S. dollar trends in the opposite direction of commodities

A falling dollar is bullish for commodities; a rising dollar is bearish

Commodities trend in the opposite direction of bond prices

Therefore, commodities trend in the same direction as interest rates

Rising commodities coincide with rising interest rates and falling bond prices

Falling commodities coincide with falling interest rates and rising bond prices

Bond prices normally trend in the same direction as stock prices

Rising bond prices are normally good for stocks; falling bond prices are bad

Therefore, falling interest rates are normally good for stocks; rising rates are bad

The bond market, however, normally changes direction ahead of stocks

A rising dollar is good for U.S. stocks and bonds; a falling dollar can be bad A falling dollar is bad for bonds and stocks when commodities are rising

During a deflation (which is relatively rare), bond prices rise while stocks fall

The list sums up the key intermarket relationships between the four market groups-at least as they are in a normal inflationary or disinflationary environment, the likes of which existed during the second half of the last century. This held up especially well during the 1970s, the 1980s, and most of the 1990s. (The last item in the preceding list which refers to deflation was not normal in the postwar era. Later in the book I explain how deflationary pressures starting in 1997 and 1998 changed the normal relationship that had existed between bonds and stocks.) With a basic understanding of intermarket relationships, it is easier to see how well the markets followed that script at the start of the 1980s. A rising dollar led to falling commodities, which led to rising bond prices, which led to rising stock prices. Things stayed pretty much this way until 1987.


The stock market crash during the second half of 1987 was an even more dramatic example of the necessity for intermarket awareness. It happened swiftly and the results were dramatic and painful. Those who ignored the action in related markets during the first half of that year were blindsided by the market collapse during the second half. As a result, they sought out scapegoats like program trading and portfolio insurance (futures-related strategies that can exaggerate stock market declines) to explain the carnage. While these two factors no doubt added to the steepness of the stock market decline, they did not cause it. The real explanation for the stock market crash that year is much easier to explain, but only if viewed from an intermarket perspective. It started in the bond and commodity pits in the spring of that year.


During the four years after 1982, two of the main supporting factors behind the stock market advance were falling commodity prices (low inflation) and rising bond prices (falling interest rates). In 1986, both of those markets started to level off; commodities stopped going down and bond prices stopped going up. The intermarket picture did not really turn dangerous, however, until the spring of 1987. In April of that year, the CRB Index of commodity prices turned sharply higher and "broke out" to the highest level in a year. At the same time, bond prices went into a virtual freefall. (Rising commodity prices usually produce lower bond prices.) These intermarket trend changes removed two of the bullish props under the stock market advance and gave an early warning that the market rally was on weak footing. Figure 1.4 shows the inverse relationship between bond and commodity prices from 1985 to 1987. It shows the CRB Index rising above a neckline (a trendline drawn over previous peaks) in the spring of 1987 (which completed a bullish head and shoulders bottom) just as bond prices were falling under the lower trendline in a yearlong triangular pattern-a bad combination for stocks since it suggested that rising inflation was pushing interest rates higher.


The stock market rally continued for another four months into August 1987 before finally peaking. The fact that bond prices peaked four months ahead of stocks demonstrates the tendency for bonds to turn ahead of stocks. Again, bonds are considered to be leading indicators of stocks. Figure 1.5 shows the divergence between bond and stock prices from the spring of 1987 (when bonds peaked) until August (when stocks peaked). Bonds fulfilled their role as a leading indicator of stocks. By October, bond yields had climbed above 10 percent. Probably more than any other factor, this jump in interest rates to double-digit levels caused the October stock market crash. Figure 1.6 shows that the October 1987 plunge in stocks followed closely after bond yields climbed over 10 percent. In addition, the U.S. dollar played a role.


The dollar, which had been declining earlier in the year, started a rebound in May that lasted into the summer. This rebound ended in August as the stock market peaked. Both markets then fell together. A second rally attempt by the dollar during October also failed, and its subsequent plunge coincided almost exactly with the stock market crash. Figure 1.7 shows the close correlation between the peaks in the dollar and stocks during August and October 1987. Consider the sequence of events going into the fall of 1987. Commodity prices had turned sharply higher, fueling fears of renewed inflation. At the same time, interest rates soared to double digits. The U.S. dollar suddenly went into freefall (fueling even more inflation fears). Is it any wonder that the stock market finally ran into trouble? Given all of the bearish activity in the surrounding markets, it is surprising that the stock market held up as well as it did for as long as it did. There were plenty of reasons why the stock market should have sold off in late 1987. Most of those reasons were visible in the action of surrounding financial markets-like commodities and bonds-but not necessarily in the stock market itself. The events of 1987 provide a textbook example of how intermarket linkages work. That traumatic market year also makes a compelling argument as to why stock market participants need to monitor the other three financial markets.


Another important lesson of 1987 is the fact that the market crash was global in scope-world markets fell together. This is important for two reasons. First, it is a dramatic demonstration of how global stock markets are linked. Second, it shows that world stock markets become even more closely linked during serious downturns than they are normally. At such times, global diversification becomes a myth. (The same phenomenon of a global bear market in stocks is apparent starting in 2000.) Global linkages are not limited to stock markets, either. Foreign currencies are linked to the U.S. dollar. Trends in inflation and deflation (which are reflected in commodity prices) are global.

There is another lesson having to do with the global nature of the 1987 stock market crash. Many market observers at the time took the narrow view that various futures-related strategies-like program trading and portfolio insurance-actually caused the selling panic. They reasoned that there did not seem to be any economic or technical justification for the stock market collapse. The fact that the equity crash was global in nature, and not limited to the U.S. market, argued against such a narrow view, especially since most foreign markets at the time were not affected by program trading or portfolio insurance.


During the Iraq crisis of 1990 and again in 2003, rising energy prices slowed global economic growth and contributed to weakness in all of the world's major stock markets. The rise in oil prices during 1990 also pushed interest rates higher all over the world and once again showed how global interest rates rise and fall together. After 1998, a close correlation developed between falling global interest rates-including those in the United States-and a falling Japanese stock market, which was caught in the grip of deflation. Figure 1.8 shows interest rates moving higher around the globe during the inflationary 1970s and then falling together during the disinflationary 1980s and the deflationary 1990s.


Of the four financial markets used in intermarket work, the dollar is probably the most difficult to fit into a consistent intermarket model. Long delays between trend changes in the dollar and other markets are part of the reason for that. The events leading up to 1987 provide a good example of why this is so. After rallying for five years, the dollar started to drop in 1985, largely due to the Plaza Accord, a five-nation agreement designed to drive down the price of the dollar. Normally, a falling dollar would give a boost to commodity prices. But this boost did not come-at least not right away.


Excerpted from Intermarket Analysis by John Murphy Excerpted by permission.
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From the Publisher
“…valuable reading for the professional because it provides a detailed overview of a subject that still attracts relatively little attention...” (The Technical Analyst, April 2004)

Meet the Author

JOHN J. MURPHY, former technical analyst for CNBC, is the Chief Technical Analyst for and President of MurphyMorris ETF Fund. He has over thirty years of market experience and is author of several bestselling books, including Technical Analysis of the Financial Markets–which is widely regarded as the standard reference in the field. His book Intermarket Technical Analysis (Wiley) created a new branch of technical analysis emphasizing market linkages. Stocks&Commodities Magazine (October 2002) described his intermarket work as "unparalleled." His third book, The Visual Investor, also published by Wiley, applies charting principles to sector analysis. John has appeared on Bloomberg TV, CNN Moneyline, Nightly Business Report, and Wall $treet Week with Louis Rukeyser, and has been quoted in Barron’s and other prominent financial publications. He received a BA in economics and an MBA from Fordham University in New York. In 1992, John was given the first award for outstanding contributions to global technical analysis by the International Federation of Technical Analysts, and is the recipient of the 2002 Market Technicians Association Annual Award.

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