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Wiley Trading Series



Intermarket Analysis

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding. The Wiley Trading series features books by traders who have survived the market’s ever changing temperament and have prospered—some by reinventing systems, others by getting back to basics. Whether a novice trader, professional or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future.

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Intermarket Analysis Profiting from Global Market Relationships


John Wiley & Sons, Inc.

Copyright © 2004 by John Murphy. All rights reserved. Some of the figures in Chapters 1, 2, and 3 were created by Knight Ridder’s Tradecenter. Tradecenter is a registered trademark of Knight Ridder’s Financial Information. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, e-mail: [email protected]. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317-572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at ISBN: 0-471-02329-9 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1

To Anne, a great poet and to Tim, a great brother




Introduction to Intermarket Analysis


1. A Review of the 1980s


2. 1990 and the First Persian Gulf War


3. The Stealth Bear Market of 1994


4. The 1997 Asian Currency Crisis and Deflation


5. 1999 Intermarket Trends Leading to Market Top


6. Review of Intermarket Principles


7. The NASDAQ Bubble Bursts in 2000


8. Intermarket Picture in Spring 2003


9. Falling Dollar During 2002 Boosts Commodities


10. Shifting from Paper to Hard Assets


11. Futures Markets and Asset Allocation


12. Intermarket Analysis and the Business Cycle


13. The Impact of the Business Cycle on Market Sectors


14. Diversifying with Real Estate


15. Thinking Globally





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owe thanks to a lot of people who helped put this book together: Pamela van Giessen, Executive Editor at Wiley, for talking me into doing it in the first place; Jennifer MacDonald and Joanna Pomeranz for making sure that everything wound up in the right place; Heidi Shelton and Pete Behmer at for producing great looking charts; John Carder at Topline Investment Graphics for his innovative historical charts; Tim Murphy for his help with the cover design and computer graphics; those market analysts who generously allowed me to draw from their work including Ned Davis, Ken Fisher, Ian Gordon, Martin Pring, and Sam Stovall. And, finally, the McTooles family who kept my spirits up while I was writing this book.



Introduction to Intermarket Analysis

n 1990, I completed a book entitled Intermarket Technical Analysis: Trading Strategies for the Global Stock, Bond, Commodity, and Currency Markets. My point in writing it was to show how closely related all the financial markets really are, both domestically and internationally. The book’s main thesis was that technical analysts need to broaden their chart focus to take these intermarket correlations into consideration. Analysis of the stock market, for example, without consideration of existing trends in the dollar, bond, and commodity markets was simply incomplete. The book suggested that financial markets can be used as leading indicators of other markets and, at times, confirming indicators of related markets. Because the message of my earlier text challenged the single market focus of the technical community, some questioned whether this newer approach had any place in the technical field. Many questioned whether intermarket relationships existed at all—and whether they could be used in the forecasting process. The idea that global markets are linked to each other was also viewed with some skepticism. How things have changed in just one decade. Intermarket analysis is now considered a branch of technical analysis and is becoming increasingly popular. The Journal of Technical Analysis (Summer– Autumn 2002) asked the membership of the Market Technicians Association to rate the relative importance of technical disciplines for an academic course on technical analysis. Of the fourteen disciplines included in the poll, intermarket analysis ranked fifth. Intermarket work has come a long way in ten years.


EARLIER BOOK COVERED THE 1980s My earlier text focused on events in the 1980s starting with the end of the commodity bubble at the start of that decade. This ended the hyperinflation of xi



the 1970s when hard assets like commodities soared and paper assets (like bonds and stocks) soured. The 1980 peak in commodities ushered in a twodecade disinflationary trend that coincided with major bull markets in bonds and stocks. The biggest financial event of the 1980s—the 1987 stock market crash—provided a textbook example of how markets are related to each other and the necessity for paying attention to those related markets. A surge in commodity prices—and a collapse in bond prices—during the first half of 1987 gave ample warning of an impending stock market decline during that year’s second half. Three years later during 1990, as the previous book was going to press, global financial markets were just starting to react to Iraq’s invasion of Kuwait in August of that year. Gold and oil prices surged—while stock markets around the world fell. Interestingly, thirteen years later (at the start of 2003), market observers were facing the prospect of another Iraq war and were studying anew the 1990–1991 market reactions to look for parallels. History has a way of repeating itself, even in intermarket work.

JAPANESE BUBBLE BURSTS IN 1990 Another important event which happened at the start of 1990 is still having global repercussions more than a decade later. The bubble in the Japanese stock market burst. This started a thirteen-year descent in that market (which represented the world’s second largest economy) that turned into a deflation (a decline in the prices of goods and services). Over a decade later, western central bankers were studying the Japanese deflation model to find ways to combat increasing signs of deflation in western economies. Some of the charts presented in this book also bolster the view that Japanese deflation was one of the major contributing factors to the decoupling of bonds and stocks in the United States years later when rising bond prices starting in 2000 coincided with falling stock prices.

THIRD ANNIVERSARY OF 2000 MARKET TOP March 10, 2003 marked the third anniversary of the ending of the Nasdaq bubble that signaled the start of the worst bear market in decades. A 50 percent decline in the S&P 500 was the worst since 1974. The Nasdaq’s loss of 78 percent was the worst since the stock market crash from 1929–1932 in the midst of the Great Depression. Market historians had to go back to study



these two periods to gain some insight into market behavior. What made comparisons between these two earlier periods complicated was that each of them was caused by a different economic event. The bear market in stocks during the 1970s was associated with a period of rising commodity prices— and hyperinflation. The bear market of the 1930s, however, was associated with a period of economic deflation. While both situations are bad for stocks, deflation is the more difficult to counter. Starting in 1998, the word deflation was being heard for the first time since the 1930s. This happened as a result of the Asian currency crisis that gripped the world during 1997 and 1998. Within five years, global deflation had spread from Asia and was starting to infect global bond and stock markets everywhere—including the United States. More than any other factor, the reappearance of deflation changed intermarket relationships that had existed over the prior forty years. These changes are why I am writing this book—to show what has worked according to the older intermarket model and, more importantly, what has changed. Intermarket analysis is based on relationships (or correlations) between markets. It is not, however, a static model. Correlations between financial markets can change over time. They do not change randomly, however; there is usually a good reason. The main reason for some of the changes that started in the late 1990s was the growing threat of deflation.

THE DEFLATION SCENARIO In the 1999 revision of my book Technical Analysis of the Financial Markets, I included a chapter on intermarket analysis which reviewed the historic relationships that had been working for several decades. I also added a new section which was entitled “Deflation Scenario.” This section described the collapse in Asian currency and stock markets starting in the middle of 1997; the severe decline had an especially depressing effect on global commodity markets like copper, gold, and oil. For the first time in generations, analysts starting expressing concern that a beneficial era of disinflation (when prices are rising at a slower rate) might turn into a harmful deflation (when prices of goods actually fall). How the markets reacted to that initial threat of deflation defined the intermarket model for the next five years. Commodity prices fell while bond prices rose. This was nothing new—falling commodity prices usually produce higher bond prices. What changed, though, was the relationship between bonds and stocks. During 1998, stocks were sold all over the world while money poured into U.S. Treasury bonds in a global search for



safety. In other words, stocks fell while bonds rose. This was unusual and represented the biggest change in the intermarket model. Disinflation (which lasted from 1981 through 1997) is bad for commodities but is good for bonds and stocks. Deflation (which started in 1998) is good for bonds and bad for commodities—but is also bad for stocks. In a deflationary climate, bond prices rise while interest rates fall. Falling interest rates, however, do not help stocks. This explains why a dozen easings by the Federal Reserve in the eighteen months after January 2001 were unable to stop a falling stock market that had peaked at the start of 2000.

INTERMARKET MODEL FROM 1980 TO 1997 This book begins with a quick review of the 1980s, starting with the big intermarket changes that helped launch the greatest stock bull market in history. We will also revisit the 1987 stock market crash—because of its importance in the development of intermarket theory and its role in changing this theory into reality. The 1990 bear market was just starting as I was completing my earlier book. We will study this year in more depth, especially given its relevance to global events thirteen years later. Traditional intermarket relationships held up quite well during the 1994 bear market and continued to do so until 1998.

THEN CAME 1998 AND THINGS CHANGED The rest of this book deals with market events from 1998 onwards. That year represented a sea change in the intermarket model. We will study market forces leading up to the bursting of the stock market bubble in the spring of 2000—and the ensuing three years of stock market decline. Deflation plays a key role from 1998 on. Global markets became very closely correlated during the late 1990s and the first three years of the new millennium. This was mainly due to global overinvestment in technology stocks during the latter stages of the Nasdaq bubble—and the ensuing global collapse after the bubble burst. Deflationary trends were also global in scope. The fact that virtually all world markets collapsed together after 2000 called into question the wisdom of global diversification (when stock investments are made in foreign markets to reduce overall risk). During global bear markets in stocks, all world markets become closely correlated to the downside. This happened during the crash of 1987—and again after 2000. It was also another manifes-



tation of the intermarket reality that financial trends are usually global in nature. This includes the direction of stock markets, interest rates, currency markets, and trends in inflation and deflation.

THE ROLE OF OIL In 1999, rising oil prices set in motion a series of events that led to the start of a bear market in stocks in the spring of 2000 and the onset of a recession a year later in the spring of 2001. Rising oil prices have contributed to virtually every U.S. recession in the last forty years. 1999 was no exception. The surge in oil prices led the Federal Reserve to tighten interest rates, which helped end the longest economic expansion since the 1960s. This action by the Fed led to an inverted yield curve as 2000 started; this is a classic warning sign of stock market weakness and impending recession. All of these trends were clearly visible on the price charts at the time, a fact which is demonstrated in the book. Unfortunately, the economic community— together with most Wall Street analysts—either did not see the classic warning signs of trouble or simply chose to ignore them. Another change from my previous book is the increasingly important role that sector rotation plays in intermarket work. Different stock market sectors take over market leadership at different points in the economic cycle. In 1999, oil stocks were the market’s strongest sector. This is usually a bad sign for the economy and the stock market. You will see how valuable sector “signals” were during the crucial years of 1999 and 2000—and how some defensive market sectors started new uptrends just as the Nasdaq peaked.

THE RESURGENCE OF GOLD During the twenty years from 1980 to 2000, gold was in a major downtrend. This was due to the disinflationary trend of that two-decade period and to the fact that gold generally does poorly during bull markets in stocks. Because gold is bought mainly during times of crisis, there is not much need for it during a super bull market in stocks. A strong dollar during most of those years also kept gold out of favor. This started to change in 2000, however. During that watershed year, the twenty-year bull market in stocks came to an end. At the same time, a seven-year bull market in the U.S. dollar was ending. These two factors combined to light a fire under a moribund gold market. Over the

Praise for


“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

Cover Design: Loretta Leiva Cover Image: globe, © jimmyjamesbond Author Photograph: © Anthony Loew

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