THOUGHTS ON INTERMARKET ANALYSIS
THE NEW BOOK IS DONE... I spent this morning at my publisher in New York getting a final look at the pages for my new book on intermarket analysis. I'm happy to say that the book is totally done and should be available by the start of the new year. As many of you may know, I wrote a book on Intermarket Technical Analysis in 1990 just as the first Persian Gulf War was starting. It became clear, however, that the subject needed a fresh look after year 2000. That led to the new book. Intermarket analysis, in my opinion, adds an extremely valuable dimension to technical work. It blends together action in four major market groups -- bonds, stocks, commodities, and currencies -- and shows how they impact on one another. But it goes far beyond that. Intermarket work also covers which market sectors (or industry groups) lead the stock market at various stages of the business cycle. It also suggests which asset class (bonds, stocks, or commodities) to concentrate in at various stages of the business cycle. Intermarket work also takes activity in foreign markets into consideration. As an example of that, deflationary trends that started with the Asian currency crisis during 1997 started the global deflationary trend that ultimately led to the global bear in stocks starting in 2000 -- and the bull market in bonds. Over the past year, strength in Asia (especially China) is leading a global economic recovery. This weekend President Bush is visiting Asia in an attempt to convince them to let their currencies rise. The U.S. wants a weak dollar. That's bullish for commodity markets. Charts 1 and 2 show that the falling dollar has been accompanied by rising commodity prices since 2002. A bounce in the dollar this week contributed to a downtick in the CRB Index. Intermarket analysis is an especially fertile field for technical research. It's also a potentially profitable one. I'll be expanding on more intermarket themes in the months ahead. I hope you find it as interesting as I do.
Chart 1
Chart 2
WHY RISING COMMODITIES ARE GOOD FOR STOCKS... One of our members asked about my recent comment that rising commodities were good for stocks. That hasn't always been the case. That's one of the intermarket relationships that's changed somewhat over the past five years. In a deflationary environment, stocks and commodities become closely correlated. At the same time, bond prices usually move in the opposite direction. When an economy is dealing with a deflationary threat, rising commodity prices are a good thing and are usually associated with rising stock prices. In the early 1930s, stocks and commodities bottomed together and signalled that deflationary pressures were easing. That's pretty much what happened this year. Stocks and commodities were the two strongest classes. Rising industrial commodities are also a sign of economic strength. The two weakest assets were bonds and the dollar. That also makes sense. Rising commodities usually lead to higher bond yields. Rising stock prices signal economic strength. That favors stocks over bonds. That's why stocks outperformed bonds this year. The weak dollar is part of government policy to reflate the economy. The top beneficiary of a weak dollar is commodity markets. The two next charts compare industrial metal prices to the S&P 500. Both peaked during 2000 as the economy started to weaken (and as bond prices started to rise). Commodities bottomed before stocks during 2002 (largely due to the collapse in the dollar that year). Notice that the second bottom is commodities last October coincided witht the stock market bottom. Both were sending a message that the economy was bottoming. Notice, however, that commodities are the stronger of the two markets.
Chart 3
Chart 4
FIDELITY INDUSTRIAL MATERIALS... On Thursday, I listed three mutual funds that benefit from rising commodity prices. One of our members asked which of the Fidelity funds were closely tied to rising commodity prices. Actually, there are several Fidelity sector funds that are tied to commodities including gold, energy, natural gas, natural resources, and paper & forest products. Each of those, however, covers only a portion of the commodity field. In my opinion, the Fidelity Select Industrial Materials may be the best proxy for commodities as an asset class. The chart shows that fund recently breaking out to a new high. It looks a little over-extended at present, but it's trend is clearly up.
Chart 5
STOCK MARKET PULLS BACK ON FRIDAY... On Wednesday, I talked about the stock market being somewhat overbought. Several of the market indexes touched their upper Bollinger band and had daily oscillators is overbought territory. The daily stochastic lines for the QQQs have turned down from overbought territory over 80. The daily MACD lines are still positive, but not by much. Friday was also the third time in three days that prices sold off on heavier volume. That's normally a sign of profit-taking. The market has discounted a lot of good news. That leaves a lot of room for disappointment -- especially during the month of October. The Nasdaq 100 was the day's biggest index loser, which reflected relative weakness in technology stocks. That's not good either. No serious damage was done this week. But it does look like the market is headed for a soft spot. The first test of support for the QQQs will be the 20-day line which sits just over 34.
Chart 6
