Intermarket Analysis

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Alex Spiroglou, DipTA (ATAA)ECF SecuritiesDerivatives Dept

Speaker BackgroundMr Spiroglou is working in the Derivatives Dept of Energon Capital Finance.Performing Advisory Derivatives Portfolio Management for a private client base,and also produces the “Daily Market Strategies” report , covering the commodities, equity, currency and fixed income markets based on quantitative, intermarket and technical criteria.He holds a Bsc in “Banking and International Finance” from City Univercity, LondonHe also has the following professional qualification titles :- Investment Management Certificate (U.K. Society of Investment Professionals)- Diploma in Technical Analysis (Australian Technical Analysts Association)- Market Maker Certificate (ADEX)- Client Consultant Certificate (ADEX)- Investment Consultant Certificate (HCMC)

If you interested in the Notes accompanying this Presentation , feel free to email me at : [email protected]

q PART I ………….……………………………..…..2

- Introduction

- The Necessity for Intermarket Analysis

- Basic Principles

- Asset Allocation & Market Timing Uses

q PART II ………….……………………………..…..17

- Comparison to Technical & Fundamental Analysis

- Limitations of Intermarket Research

q PART III ………….…………………………….…..25

- Systemizing Intermarket Analysis

- Mechanical Trading

- SemiMechanical Trading

Stocks

Bonds

Commodites

Forex

� What is Intermarket Analysis ?

� What is the Markets’ Message ?

� Is it just another Theory ?

� Think like a Fundamentalist , Trade like a Tehnician

PART I (Introduction)

� What is so “New” about the New Global Economy ?

PART I (The Necessity of a Global View)

� Nikkei & US 10Y Yields

PART I (The Necessity of a Global View)Examples

� Asian Influence on Global Rates & Stock Markets

PART I (The Necessity of a Global View)Examples

The Assumptions behind Intermarket Analysis

� All markets are interrelated, they don’t move in isolation.

� Intermaket work provides background data.

� Intermarket work uses external , as opposed to internal data.

� Heavy emphasis is placed on the futures market

PART I (Basic Principles)

Economic Rationale / Framework



Relationships Framework

1. Commodity prices and bond prices usually trend in the opposite direction. (Commodity prices and bond yields usually trend in the same direction.) 2. Bonds and stocks move together (unless in deflation)3. Bonds lead the stock market at the turns4. The dollar and commodities move inversely (particularly gold).5. A rising dollar is normally good for U.S. stocks and bonds because it is noninflationary.6. Gold leads turns in the CRB at the turns

Equally Important :7. Relationships between various futures markets and related stock groups (e.g. COMEX Gold & gold mining shares)8. The relationship between the CRB Index and the various commodity groups 9. Action between related commodity groups (precious metals and energy markets)1O. Action within commodity groups (gold to platinum, crude and heating oil)11. Action between currency pairs

PART I (Basic Principles)Rising Bond Prices are Usually Good for Stock Prices

PART I (Basic Principles)The line along the bottom shows the positive correlation between

T-bond prices and the S&P 500

PART I (Basic Principles)Commodity Prices and Bond Prices Normally Trend in the Opposite

Directions


A Rising Dollar Normally has a Depressing Effect on Commodity Markets


The US$ and Gold Prices Usually Trend in Opposite Directions

PART I (Basic Principles)Usually a Very Close Linkage Between

Bond Prices and Utilities


Chronological Framework

PART I ( Asset Allocation & Market Timing Uses)

Economic Forecasting


Sector Rotation


Market Timing

Leading Market Relationships“Leading” markets, could pinpoint potential trading

opportunities, as they are about to unfold-“Leading” markets could help identify trends so traders could catch a bigger portion of each move

Coincident Market Relationships-False signals could be minimized because the full picture is taken into consideration, not just a small piece of it-Stops could be placed on how related markets are affecting the market being traded.-Divergences between correlated markets can help spot short / medium / long term price disclocations.


What other Strategies can be devised and Opportunities exploited ?

Ø Intermarket Spreads

Ø Intramarket Spreads

Ø Pairs Trading

PART II (Comparison to Single Market TA )

Single Market Technical analysis (on its own) is incomplete , as an exclusive technical focus is counter-productive. Reliance on price based indicators (solely) may limit our understanding of what drives the markets. In other words, by obsessing about price, we might be sacrificing deeper insight into the root causes of price behaviour.Intermarket Analysis - by turning the focus of the technical analyst outward instead of inward- provides a more rational understanding of technical forces at work in the marketplace. It is impossible to do intermarket work without understanding of the fundamental forces behind those moves.

By incorporating “exogenous” factors – say interest rates – we add a helpful causative dimension to our treatment.This way the timing logic takes into account not only price action – which can be deceptive – but some of the defining properties that help shape and determine price behaviour

PART II (Comparison to Fundamental Analysis )

� Transferable

� Global , not Local

� Market Driven

� Focal Points

PART II (Comparison to Fundamental Analysis )EXAMPLES

(E715)

Monthly Data 12/31/1974 - 2/28/2005

Consumer Price IndexYear-to-Year Change

2/28/2005 = 3.0% Scale Left

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1011121314

Commodity Basket (DJ & CRB

Commodity Indices)2/28/2005 = 461.9

Scale Right

240260280300320340360380400420440

Commodity BasketYear-to-Year Change

2/28/2005 = 9.7% Scale Left

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Inflation vs Commodity Prices

PPI / CPI & CRB Index

PART II (Limitations of Intermarket Research)

� Information Overflow

� Limited Historical Data

PART III ( Systemizing Intermarket Analysis )

� We have no choice

� Structure , Discipline & Risk Values

� Markets provide enormous amounts of information

� Our Competitors do it…

Why Systemize ?


� Can be…

� Can be classified as…

� Can be used as…

� Can be used in…

Market Correlations…


Mechanical Trading Discretionary Trading

Semi- Mechanical Trading


What is Mechanical Trading

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Why not go completely Mechanical ?

� Not everything can be modelled

� Experience cannot be “pigeon-holed”

� No (modelled) Strategy works across all time frames

� Systems are often over-optimised


Semi – Mechanical Trading

The essence of the Semi-Mechanical Trading approach is not to “forecast” & predict the

future (unlike discretionary trading), but to objectively identify substantially different

average return / risk characteristics of the present.

Mechanical Entry / Exit Rules (signals) can be overiden and are usually combined with the

underlying technical picture in order to align our investment position with the specific

market characteristis that we identify at any given point in time.

Objective Models / Ranking Systems are devised (providing weight of the evidence) in

order to facilitate a disciplined yet flexible decision – making process.

PART III ( Systemizing Intermarket Analysis )Examples

ISM & the S&P 500

(S1100)

Monthly Data 7/31/1950 - 2/28/2005 (Log Scale)

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Signals Generated When ISM Index:Declines by 7 Points = BuyRises by 22 Points = Sell

Profitable Trades: 78%Gain/Annum: 9.7%Buy-Hold Gain/Annum: 8.0%Latest Signal 7/31/2004 = 1101.72

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118155203267350459602790

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Declining = Bullish

Rising =Bearish

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Standard & Poor's 500 Stock Index

Source: Institute for Supply ManagementISM Report on BusinessInstitute for Supply Management Price Index

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ISM & BondsMonthly Data 1/31/1980 - 2/28/2005 (Log Scale)

(B0615)

Standard & Poor's Long-Term Government Bond Index

S&P L-T Gov't Bond Index Gain/Annum When:

PMI Point Gain/ %Change Is: Annum of Time

Above 3.4 -4.2 36.2

Between -3.5 and 3.4 3.8 29.2

* -3.5 and Below 8.5 34.6646975818895

102111120129140151

646975818895

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Institute for Supply Management Index (PMI)

Shaded areas representNational Bureau of

Economic Research recessions.Source:Institute for Supply Management,

ISM Report on Business

2/28/2005 = 55.3

Manufacturing Expanding

Manufacturing Contracting

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Manufacturing Conditions Improving

Manufacturing Conditions Weakening

2/28/2005 = -6.8PMI 12-Month Point Change

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ISM PMI Index (12-Month Point Change)


Bonds & Commodities

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Daily Data 8/29/1979 - 3/28/2005 (Log Scale)

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Treasury Bond Futures (Perpetual Contract)

Profitable Trades: 64%Gain/Annum: 10.4%Buy-Hold Gain/Annum: 1.5%Latest Signal 1/24/2005 = 114.34

Signals require confirmation from two of the three indicators belowSource: Commodity System, Inc. (CSI)

www.csidata.com44485257636975839199

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Commodity Research Bureau'sFutures Price Index

Index rises by 6.5% = sell bondsIndex falls by 6.8% = buy bonds

Next Buy at 300.50

191206222240259280302326

191206222240259280302326

Commodity Research Bureau'sSpot Raw Industrials Price Index

Index rises by 2.2% = sell bondsIndex falls by 1.7% = buy bonds

Next Buy at 329.92219234250267285304325347

219234250267285304325347

Goldman Sachs Commodity IndexIndex rises by 9.3% = sell bondsIndex falls by 7.9% = buy bonds

Next Buy at 354.96

Source: Goldman Sachs Commodity Index (GSCI) R133153176203234269310358

133153176203234269310358

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Three Commodity Indexes -- Signal Basis


S&P 500 & CommoditiesWeekly Data 1/19/1968 - 3/24/2005 (Log Scale)

(S970)

DJIA Gain/Annum When:

CRB Index Smoothed Gain/ %Y/Y Percent Change Annum of Time

* Above 108.2 -2.1 31.2

Between 96 & 108.2 7.5 38.4

96 and Below 16.1 30.4

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High Inflationary Pressures -- Bearish

Low Inflationary PressuresBullish

Three-Week Moving Average3/24/2005 = 113.0

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Commodity Research Bureau Futures Price Index (Year-to-Year Change)

Dow Jones Industrial Average

Concluding Remarks

“Although the scope of intemarket analysis is broad, forcing us to stretch our

imaginations and expand our vision, the potential benefit is well worth the

extra effort. I am excited about the prospects of intermarket analysis …. The

question is no longer whether or not we should take intermarket comparisons

into consideration, but rather how soon we should begin..”

John J. Murphy

Market Correlations…

NOTES

This presentation is largely informational and by no means exhaustive.

More advanced strategies (that have been developed based on the ideas pioneered by

Mr Murphy ) have not been presented as they are :

(i) beyond the scope of the presentation

(ii) are proprietary

Charts : Some charts are courtesy of Ned Davis Research

Commentary : parts of the presentation include excerpts of Mr. Murphy’s books

REFERENCES & RECOMMENDED READING

John J. Murphy “ Intermarket Technical Analysis ”

John J. Murphy “ Intermarket Analysis, Profiting from Global Market Relationships ”

Martin Pring “ The All –Season Investor ”

Murray Ruggiero “ Cybernetic Trading Strategies ”

Mark Boucher “ The Hedge Fund Edge ”

Ned Davis “ Being Right or Making Money”

Ned Davis “The Triumph of Contrarian Investing”

Geoffrey Moore “Leading Indicators for the 1990’s”

Stephen Leeb “ Market Timing for the Nineties ”

Marty Zweig “Winning on Wall Street ”

Timothy Hays : “ The Research Driven Investor “

George Dagnino “ Profiting in Bull or Bear Markets “

Documents

Intermarket Analysis