Predicting Trends with Intermarket Analysis
Disclaimer It should not be assumed that the methods, techniques, or indicators presented in this book and seminar will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples in this book and seminar are for educational purposes only. This is not a solicitation of any order to buy or sell. “HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES IN THIS BOOK and SEMINAR HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS WE STATE MAY HAVE UNDER OR OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. ” The authors and publisher assume no responsibilities for actions taken by readers. The authors and publisher are providing investment advice. The authors and publisher do not make any claims, promises, or guarantees that any suggestions, systems, trading strategies, or information will result in a profit, loss, or any other desired result. readers and seminar attendees assume all risk, including but not limited to the risk of trading losses. Day Trading can result in large losses and may not be an activity suitable for everyone. Copyright © 1994-2007 by Pristine Capital Holdings, Inc. All rights reserved. Printed in the United States of America. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without prior written permission of the publisher.
Table of Contents Introduction Why focus on inter-related markets Pertinent inter-market groups What worries the market?
Currencies & Commodities Definitions and components General relationships and why study U.S Dollar Principles Charting inter-relationships
Bond Analysis Definition and generalizations
Sector Analysis Stock and sector r elationships Stock and commodity relationships Stock and yield relationships
Developing A Trading Bias Bullish or bearish alignment of commodity and yield movements US Dollar and implications for the economy When commodities and interest rates flag danger for the stock market
Price-yield analysis Yield Curve Measuring inflation
Concluding Thoughts
Introduction
Introduction What Moves This Whale and How Inter-Market Analysis Gives Us a Broad Market Bias? The stock market acts as a discounting barometer that reads fundamentals, technicals, and the beliefs of participants all over the world. Sector Analysis Market Internals Breadth
Bonds
Sector strength and weakness
Commodities Currencies
Compelling Technical TPMs Pattern
Sentiment
Enter per Trading Plan Manage in between
TPMs
Inter-market
Stocks
Advance-Decline, Volume, etc. Bull-Bear %, Put-Call, etc. Reversal Times
Inter-Market Analysis
Introduction Why Focus on Inter-Related Markets? The relationships between commodities, currencies, stocks and bond yields give important clues about their direction. Markets are inter-related.
It gives the markets’ insights about the economy , inflation or lack thereof It gives us c lues how one market or stock sector may move based on movements in other markets. Money flows between markets.
To understand from the markets’ point of view th e collective thoughts tha are occurring in the financial markets.
Introduction Why Focus on Inter-Related Markets? A better understanding of inter-market relationships gives traders the knowledge and confidence to trade within those markets. You do not need to become an economist!
Your goal is to be objective self-directed investor or trader that gains insights from inter-market relationships .
Inter-Market Groups Currencies - A falling currency makes foreign goods more expensive, which has the effect of increasing inflation.
Commodities – Rising or falling commodity prices increase or decrease the cost of goods, which has a direct influence on inflation.
Stocks – Rise or fall based on expectations of future earnings growth and inflation.
Bonds – The evaluation of all commodities, currencies and stock indicates expectations for the economy & inflation.
The primary factor to price stability is inflation.
What Worries The Market? Rising Gold prices – Traditionally a leading indicator of inflation. Rising Oil prices – Acts as a tax on the economy that is paid at the pumps. Businesses paying higher oil prices will attempt to pass those costs to consumers. Rising Interest rates – Makes it more expensive to borrow and run businesses, which is bearish for the economy and stocks. Rising Commodity prices – Higher commodity prices (metals, agricultural products, and energy) mean higher costs of goods. Falling Dollar – Decreases the buying power of each do llar making imports more expensive. Rising interest rates, rising commodities, and a falling Dollar together are bearish.
All point to increasing inflation!
Introduction Actual Story Headings From The Media “Strong Dollar in Canada is Squeezing Its Economy” “Drubbing of the Dollar: Dangerous or Therapeutic?” “Bond Investors Face Rate Threat (Again)”
“You Could Strike Gold in Metals, Mining, E ven Steel - - If You Act Quickly” “Fed Notes Disclose Worries That Inflation May Pick UP” “Gold is Flashing Warnings”
“Global Demand for Nickel, Copper, Gold and Other Metals is Strengthening” After this DVD, you will be able to formulate intelligent opinions from news clips like these about the inter-market relationships and tradable opportunities!
Currencies and Commodities
Currencies and Commodities
A country’s currency is its official unit of monetary exchange for goods, services and securities
The U.S. Dollar is the most traded currency in the world as the main reserve currency. Like all currencies, its actual value can change significantly.
We will look at what affects movement in the U.S. Dollar to determine its effect in other markets and currencies.
Currencies and Commodities Hogs Cattle Pork Bellies
Meats
95
Others:
310 300 290 280 270 260 250 240 230 220 210 200 190 180 170 160
Gold SilverMetals Copper Aluminum Platinum
Cocoa Sugar Cotton Orange Juice Lumber
97 98 99 00 01 02 03 04
95
Commodities are traded between countries in exchange for their currencies.
Commodity Research Bureau (CRB) is the most widely followed commodity index.
We will look at the effect movement in commodities have on currencies and inflation.
500
Energy Crude Oil Heating Oil Natural Gas
CRB
450 400
240 230 220
200
210 200
150
190
100 97 98 99 00 01 02 03 04
280
250
300 250
95
Grains Corn Wheat Soybeans
290
270 260
350
97 98 99 00 01 02 03 04
180 95
97 98 99 0 0 01 02 03 04
95
97 98 99 00 01 02 03 04
Currencies and Commodities Currencies and commodities have a direct correlation with each other because currency is exchanged for commodities, and vice versa.
A business buying commodities from another country may sell their currency (supply) and buy another countries currency (demand) to pay for that commodity.
Currencies of the countries that are large producers of commodities (Canada and Australia) typically move more with changing demand for those commodities.
The demand for a countries currency also makes it a commodity to be traded based o supply and demand for it. Forex
Currencies and Forex U.S. Dollar
90
Australia Dollar / U.S. Dollar
89 88 87 86
The Dollar’s buying power was falling
85 84
To buy one BP would cost almost two U.S. $
83 82 81
Augus t
September
O ctober
November
De 1.92 1.91 1.90 1.89 1.88 1.87 1.86 1.85 1.84 1.83 1.82 1.81 1.80 1.79 1.78 1.77
British Pound / U.S. Dollar
August
September
October
November
August
Dec
September
October
November
De c
Currencies of various countries trade against each other based on fundamental and technical data in the Forex Market. Most foreign currencies trade against the U.S. $ based on inter-market analysis.
Strong / Weak Dollar Effects Strong Dollar Advantages
Strong Dollar Disadvantages
U.S. consumers see lower prices on foreign products/services.
U.S. products become more expensive in foreign markets.
Lower prices on foreign products/services help keep inflation lower` in the U.S. It is less expensive for U.S. consumers to travel to and buy goods in foreign countries.
U.S. firms must compete with lower priced foreign goods. It is more expensive for foreigners to visit U.S.
U.S. dollars can purchase foreign stocks, bonds and commodities at lower prices.
Weak Dollar Disadvantages
It is more expensive for foreign investors and countries to buy U.S. securities and real estate.
Weak Dollar Advantages
U.S. consumers see higher prices on foreign products/services.
U.S. products become less expensive in foreign markets.
Higher prices on foreign products contribute to higher inflation in the U.S.
U.S. firms find less competitive pressure to lower prices, but can lower prices and still profit.
It is more expensive for U.S. consumers to travel to and buy goods in foreign countries.
It is less expensive for foreign tourists to visit the U.S.
It’s more expensive for U.S. Dollars to purchase foreign stocks, bonds and commodities.
It is cheaper for foreign investors and countries to purchase U.S. securities and real estate.
US Dollar and Commodities U.S. Dollar
The Dollar’s buying power was increasing
125 120 115 110
Rising commodities are considered bearish for the U.S. Dollar.
105 100 95 90 85 80
CRB Index Commodities were becoming more expensive
290 280 270 260 250
Falling commodities are considered bullish for the U.S. Dollar. There are times when this correlation diverges greatly.
240 230 220 210 200 190 180 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
There is a key to when
this correlation is closer, which we will get to.
Currencies and Commodities Rising commodity prices and a falling U.S. Dollar are inflationary.
Why?
Higher costs and lower buying power.
Falling commodity prices and a rising U.S. Dollar are deflationary. Lower costs and higher buying power.
Why?
The question is, if there is inflation or deflation based on rising or falling costs for goods and services, to what extent is it? Is it really a problem and how can we tell?
The Bond Market will tell us about expectations for inflation, or lack thereof, and the effectiveness of the Fed’s action to keep it in check. We’ll get to this soon. Gold is also an indicator of inflation expectations, and acts as a gauge of the Fed’saction of raising or lowering rates.
Let’s look at this!
CRB and Gold The CRB Index moves up as
CRB Index
demand for commodities increases and/or supply decreases.
Gold has a very close correlation with commodities.
Gold
As commodity prices rise, so do expectations of inflation.
With this simple correlation, we can create trading ideas. 78
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US Dollar - CRB and Gold The U.S. $ has an inverse correlation with the CRB and Gold, but there are times when they diverge significantly.
125 120 115 110 105 100 95 90 85 80
290 280 270 260 250 240 230 220 210 200 190 180
US Dollar The reason for this divergence will be clear when we review their inter-market relationship with interests rates.
Be a B u r is h C llis h U RB .S . G D o ol d = lla r
= old G r B - olla R C .D ish U.S l l B u a rish Be
Gold - CRB 85
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Currencies and Commodities General U.S. Dollar Principles
The Dollar is falling vs. the other currencies. The bond market may have inflation fears. Commodities and gold may have been rising. We know there’s more supply than demand. There is a mountain of news and economic indicators that affect U.S $ relative to other’s. We are not going to focus on this!
Currencies and Commodity Rich Countries 0.85
Canadian Dollar
Australian Dollar
0.80 0.75 0.70 0.65
CRIBndex
2002
290 280 270 260 250 240 230 220 210 200 190 180 2003
2004
2
JapanesYeen
Japan is not a seller of commodities, so the Yen was rising for other reasons 2001
2002
2003
2004
20
Demand for commodities results in demand for currencies of countries that produce them.
Countries needing commodities from those countries will buy the currencies of those countries to purchase those commodities.Example: Sell U.S. Dollars - Buy Australian Dollars. By monitoring the CRB Index, the trend and changes of commodities can be assessed.
Foreign Currencies and US Bonds The EURO was appreciating significantly against the U.S.$, which resulted in losses for EURO investors in U.S. Bonds
145 140 135 130 125 120
10-Yr. Note priced in YEN
115
10-Yr. Note priced in EUROS
10-Yr. U.S. Note
120
10-Yr. U.S. Note
115 110 105
1
2002
2003
2004
2
1
2002
2003
2004
Foreign governments and business taking Dollars for goods and services can use those dollars to buy U.S. Bonds. Although foreign investors can buy U.S securities cheaper when their currency is appreciating against the U.S. Dollar, they can lose overall when the U.S Dollar continues to depreciate. Japanese investors buying U.S. Bonds faired much better than European investors over the period shown because the EURO appreciated in value more than the YEN against the U.S. Dollar.
Foreign Currencies and US Stocks U.S. Dollar vs. British Pound
0.85
U.S.$ weaker than BP
U.S.$ Stronger than BP
0.80
S&P 500 in British Pound
S&P strong, U.S.$ weak
0.75
0.70 0.65 0.60 0.55 0.50
S&P 500 S&P and U.S.$ strong at the same time
0.45
S&P and U.S.$ weak at the same time
0.40 5
1996
1997
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2001
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2003
2004
1995
1997
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2000
2001
2002
2003
It will cost more for a foreign investor to invest in the S&P 500 when the U.S Dollar is
2004
appreciating against that currency, and less when the U.S Dollar is depreciating against it. Once they have invested, their return will follow the S&P 500 as long as the direction of U.S. Dollar performance against that currency and the S&P 500 continues to move in the same direction. When the S&P 500 moved up and the U.S. Dollar remained weak against the Pound, a British investor did not enjoy the returns that a U.S. investor did.
Currencies and Equity Markets H
U.D S.ollar
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S
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00
01
02
03
04
S&P 500
Gold
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99
00
01
02
03
04
A Falling U.S. $ is bullish for Gold
(inflation).
Gold reflects the market’s view on inflation and often trends opposite stocks. The H&S top in the U.S. $ and
historically low interest rates (not shown) 91
92
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96
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98
99
00
01
02
03
04
were indications to keep an eye on Gold.
Currencies Affects Inflation 180
Copper priced in U.S. $
Copper priced in EUROS
170 160 150 140 130 120 150 145 140
Copper
Copper
135 130 125 120 115 110 105 100 2004
Mar
Ap r
Ma y J u n J u l
A u g S e p Oc t
Nov Dec
c 2004
Ma r
Ap r
Ma y J u n J u l
Aug Sep Oct
No v D e c
A falling currency is inflationary. To fully understand why this is the case, the above charts are copper, priced in U.S. Dollars and EUROS. The U.S. Dollar was falling against the EURO. A U.S. firm would have to pay more with its Dollars than a European firm paying in EUROS. The higher costs are added to products bought by consumers, which raises the cost of living.
Currencies and Crude Oil Crude priced in EUROS
65 60 55 50 45 40 35 30 25
Crude priced in U.S. $
20 15 55
CruO deil
CruO deil
50 45 40 35 30 25 20 15
9
2000
2001
2002
2003
2004
2
9
2000
2001
2002
2003
2004
2
Crude Oil is priced in U.S. Dollars, but there has been some sales in EUROS. The chart to the left shows Crude priced in U.S. $. The left is in EUROS. If the U.S. had to pay for Oil in EUROS, its cost would increase dramatically overnight, since it would have to exchange U.S. $ for EUROS.
Foreign Currencies and U.S. Real Estate British Pound
195 190 185 180 175 170 165 160 155 150 145 140 135
You are selling your home for $500,000. Since you live in New York, you expect to be paid in U.S. Dollars.
120
Vacationers from London 110 decide they like it and decide to 105 100 buy at your asking price.
U.S. Dollar
115
95
Interest rates play a major role in the direction of the real estate market, but upward acceleration can be seen on the index after the Dollar’s fall accelerated downward
Real Estate Index
90 85 80
700 600
1 99 8
199 9
from British Pounds is $1.92
500
The cost for your home to the vacationers in British Pounds is 300 260,417 U.S. Dollars! 400
19 97
The exchange rate for U.S. $
800
20 00
20 01
2 00 2
20 03
200 4
Currencies and Commodities U.S. consumers send U.S. Dollars overseas for goods and services.
U.S. $
Commodities EU, JY, CD, AU
When the demand for commodities is high, their prices rise and the U.S. $ falls. U.S. companies needing to buy raw commodities may sell U.S. $ and buy foreign currency to pay for them.
Foreigners buy U.S. Dollar-based assets with those U.S. Dollars. U.S. Stocks, Bonds, Real Estate and Foreign Oil. They can also sell them in exchange their own or other currencies. Forex
BONDS
Bond Basics A bond is a debt to pay back a loan over a specified period of time, at a specified rate of interest. The longer the period of time to pay back the debt, the higher the expected return by investors (e.g., 3-Month versus 30-Year). U.S. government bonds are considered risk-free compared to corporate debt. The higher the perceived risk of default, the higher the expected return by investors (e.g., Government bond versus corporate debt).
Bond Basics Bond Prices
Bond Price-Yield Basics
Bond Prices and Yields move inverse to each other. As prices move down, yields move up and vice versa.
Bond Yields
uary
March
April
May
June
July
August
September
November
Decemb
Bond Basics Long-Term Rate
Long-term rates are controlled by the market. While influenced by the Fed’s actions on short-term rates, longer-term expectations for inflation are what moves it.
Short-Term Rate
Short-term rates are controlled by the Federal Reserve, and shortterm bond yields follow. 1994
19 95
1996
1997
19 98
1999
2000
2001
2002
2003
2004
2005
Bond Basics Normal Yield Alignment
30-Year 15-Year
5.5
5.0
10-Year 4.5
5-Year
Their trends can give
3-Year
direction of stocks, since
2.5
they reflect the bond
market’s view on commodities, currencies, 1.5 2.0
and the economy.
3-Month 1.0
February March
April
M ay
June
July
us clues to the future
3.0
2-Year
mber 2004
generally trend together.
4.0
3.5
1-Year 6-Month
Various maturities
Short-Term Bond Guidelines Short-term interest rates (yields) follow the Federal Reserve’s adjustments to the Fed Funds Rate.
Short-term rates rising, tighten the supply of money, eventually slowing the economy. This also tends to support the U.S. $ by raising its yield in relation to other currencies. Forex
Short-term rates falling, loosen the supply of money, eventually stimulating the economy. This also tends to weaken the U.S. $ by lowering its yield in relation to other currencies. Forex
Long-Term Bond Guidelines Long-term interest rates (yields) fall on expectations of a weakening economy and/or lower inflation expectations.
Long-term interest rates (yields) rise on expectations of a strengthening economy and/or higher inflation expectations.
The long-term bond market’s interpretation of the economy, inflation, short-terms rates, commodities and currencies is what moves this market.
Long-Term View – Short Term View Fa ll
F
ing
al l ing
30-Year Yields lon g-t erm
g in is sh
9.0
m er -g t n lo
-t er
8.0 7.5 7.0
is
F allin g
6.5
m
R
Flat to stable long-term
8.5
R or t
3-Month Yields
9.5
g in
or sh
r te t-
m
6.0
sh
5.5 5.0
or tte r
m
4.5 4.0
i is R
3.5 3.0
Market’V s ie w 989
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2.5 1992
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Fed’V s ie w 8
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2003
g n
2004
er -t ro t sh
m
2
Rising long- and short- term yields indicates inflation fears and Fed tightening. Falling long- and short-term yields indicates low inflation fears and Fed easing.
Falling or rising may not be bullish or bearish, but the two views should not meet.
Borrowing and Investing 30-Yr.
Would you want to borrow money here?
A
15 14 13
When long-term
12 11
yields are high, it
10
What about here?
9 8 7 6
B
Fed Funds Rate
4
C
D What about here?
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expensive.
5
20
Would you like to invest risk free here?
makes borrowing
When short-
15
term yields are
10
high, it attracts
5
0
money to low risk investments.
Bond Market Guidelines
While rising interest rates are viewed as bearish for stocks, rising rates after a period of declining rates indicates a strengthening economy, which is positive. While falling interest rates are viewed as bullish for stocks, falling rates after a period of advancing rates indicates a weakening economy, which is negative. The “spread” (difference) between bonds of long and short durations will be key to determining whether the amount of tightening is bullish or bearish for stocks.
Don’t Fight the Fed? S&P 500
Bear market ends
1500 1400 1300 1200
The old adage “Don’t fight the Fed” is not tru at major turning points.
1100 1000 900 800
7.0
Fed began cutting rates once bubble popped, but it was not the time to be buying stocks.
Fed Funds Rate
6.5 6.0 5.5
After 2000, the Fed’s repeated reduction in rates was “too little, too late.”
5.0 4.5
Fed raises rates per macroeconomic data, which the market absorbed.
3-Month Yields (most closely follow the Fed Funds Rates and at times lead it)
4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5
1998
1999
2000
2001
2002
2003
2004
2
The rising rates in 2004 were not bearish because of the steady prior decline.
What’s the Spread? 30-Yr. above 3-Month is an normal Yield relationship 30-Year Yields
Spread Wide
Yields Inverted
30-Yr. below 3-Month, abnormal yield relationship
Spread Narrowing
Spread Widening
The spread and/or inversion between shortand long-term rates are a key guide to recessions and potential stock market corrections. A wide spread is bullish , inversion is bearish.
3-Month Yields 1 958
195 9
1960
1961
Bond Market Anticipates the Fed 7.0 6.5 6.0
C
5.5 5.0
Fed Funds
Fed Funds
4.5 7.0 6.5
A
6.0 5.5
B
5.0
2-YeN arote
2-YeN arote
4.5 4.0
Mar
Apr May
J un
Jul
Aug
Se p O c t
Nov Dec 2001 F eb M ar
Dec
2004 Feb M ar
Apr May Ju n Jul
Aug Sep Oct
Nov Dec 20
The Bond Market anticipates the Fed’s actions and gives us a “heads up”. In 2000, the yield on the 2-Year Note was falling for several months (A) prior to the Fed cutting the Fed Funds Rate. In 2004, the yield on the 2-Year Note was rising for over two months (B) before the Fed raised the Fed Funds Rate ( C).
Economic Reports Fed Indicators Beige Book Leading Economic Indicators
Industrial Production
Business Inventories Durable Goods Orders Factory Orders Gross Domestic Product Industrial Production and Capacity Utilization
Inflation
Housing Construction Spending Existing Home Sales Housing Market Index Housing Starts New Home Sales Leading Economic Indicators
Consumer Confidence and Employment
Economic reports that monitor the economy and inflation are issued weekly. Many try to predict their movements and what they are indicating about the economy, inflation and the Fed’s Policy based on them.
Consumer Confidence Index Employment Report
Consumer Price Index Initial Jobless Claims Personal Income and Employment Cost Index Consumption Producer Price Index Real Earnings Productivity and Unit Labor Redbook Retail Averages Costs Retail Sales Purchasing Managers Index
We are only concerned with how the Bond Market re acts to these numbers, not the number themselves.
What is Inflation and How is it Measured? An increase in the amount of money or credit available (more dollars) in relation to the amount of goods or services available (low supply), which causes an increase in the general cost of goods and services. One measure of inflation is the percentage increase in the Consumer Price Index (CPI). CPI represents changes in prices of all goods and services purchased for consumption by urban households, and is viewed by plotting its annual rate of change.
CPI Annual Rate of Change
There is so much attention paid to inflation, but does it actually correlate to positive or negative stock prices? 920
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There Must be More to CPI! The market has done very well and very poorly with CPI rising and 25% Correction falling, so there must be something else to this, which we will get to! Flat S&P 500
When the CPI’s annual Rate of Change was rising (bearish) and falling (bullish), it did not have the effect it should have where marked.
CPI Annual Rate of Change
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Bond Market Studies In 1996, the New York Federal Reserve did a study on what indicators were the most reliable predictors of a recession. Stocks react before economists will confirm a recession.
The only one of six indicators that was significantly reliable was an Inverted Yield Curve
They later did a private study with over 20 factors in 1999 and still found that the only dependable indicator was the Inverted Yield Curve.
The two studies done by the Fed indicated an Inverted Yield Curve to be the only reliable indication of a recession, which does have a negative effect on stocks for obvious reasons.
For this reason, we will read the bond market’s reaction to changes in currencies and commodities and trends for indications of a changing environment for stocks.
To What Extent Have Yields Inverted?
A
B
C
6.95 6.90 6.85 6.80 6.75 6.70 6.65 6.60 6.55 6.50 6.45 6.40 6.35 6.30 6.25 6.20 6.15 6.10 6.05 6.00 5.95 5.90 5.85 5.80 5.75 5.70 5.65 5.60 5.55
D
30-Year
10-Year 5-Year
Complete inversion 3-Month November
2000
FebruaryMarch
April
M ay
Ju n e
July
August September
Novemb
5.50 5.45 5.40 5.35 5.30 5.25 5.20 5.15 5.10 5.05 5.00 4.95
A: Late 1999 yields are in proper alignment. B: The 10- and 30-Year moved under the 5-Year, which inverted them: Early warning of economic weakness! C: The 30-Year and 3Month inverted:
Early warning of recession (and bear market per technicals)!
D: Complete inversion: Macro supported aggressive bearish posture.
To What Extent Have Yields Inverted?
A
Recession concerns abate (B). 3-Month moves back under the 30-Year.
B
Recession concerns (A), but inversion is not complete!
Composite of Long- and Short-Term 30-Yr.
4.5 4.0 3.5 3.0 2.5 2.0 1.5
3-Month.
S&P 500
1.0 0.5 2.5
30-Yr.Minus3-Month
30-Yr.Minus3-Month
2.0 1.5 1.0 0.5 0.0 -0.5
1958
1959
1960
1958
1959
1960
Making a composite indicator by subtracting the 30-Yr. yield from the 3-Month yield will form a signal line that is clearer. Once the “spread” narrows to .5, it signals the yield curve is nearing an abno level and an early warning. Once under 0, the yields have become inverted.
Composite of Long- and Short-Term S&P 500
Yield Spread
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Spreads greater than 3 points are very bullish, but do not suggest a market advance initially. It takes time for a bullish monetary yield spread to take effect.
CPI and Yield Spread 1600
S&P 500
1500 1400 1300 1200
At (A), inflation was rising, but there was no ill effect until yields inverted
1100 1000 900 800
CPI Annual Rate of Change
( C) (B)
(A )
3.5 3.0 2.5 2.0
At (B), not until the spread reached 3.0 points and inflation actually turned up did the stock market move up.
1.5 1.0
( B)
4.0
Yield Spread
3.5 3.0
( C)
2.5 2.0 1.5
( A)
1.0 0.5 0.0 -0.5
1 998
1 999
2 000
2001
2002
2003
At (C), the CPI Annual
4.5
2004
20
Rate Change upperoflevels thatneared coincided with the 2000 high in the S&P 500, but the spread between yields was very bullish.
Tradable Instruments in Bonds and Currencies
BondFutures 30 Year Bonds Futures (ZB) 10-Year Note Futures (ZN) 5-Year Note Futures (ZF) 2-Year Note Futures (ZT)
Currencies 6 J – Ye n 6E - Euro 6C – Canadian 6A – Australia 6B – British Pound
Bond/YieldTrusts iShares SHY – Lehman 1-3 Year Treasury Bond Fund TLT - Lehman 20+ Year Treasury Bond Fund IE F - Lehman 7-10 Year Treasury Bond Fund AG G - Lehman Aggregate Bond Fund
Sector Analysis
Introductory Thoughts The relationships between bonds, currencies, commodities and stocks will direct our attention to tradable sectors. The relationships between various sectors and related stocks may move together or opposite each other, those relationships will offer clues to their direction. These intra-market relationships will direct you to where funds are flowing, and to tradable opportunities.
Sector Analysis 400 390 380 370 360 350 340 330
Semiconductor Index (SOX)
320 310 300 290 280 270 260 250
Higher Low
It is bullish for the broader markets to be led by the tech-heavy Nasdaq.
Semiconductors represent a large percent of the
1550
Nasdaq, so they often lead it,
1500
as they did in early March.
NASDAQ 1450 1400
1350
3 30 6 2003
13
21 27
3
10 18 24 February
3
10 March
17
24
31
7 April
14 2 1
28
5 May
12
Rallies in the Nasdaq
1300
without the relative strength
1250
of the semis are suspect.
Sector Analysis 460
SOX Index SOX Index
B
450 440 430 420 410 400 390
The SOX making a lower low in early Sept. (A) was a concern for the Nasdaq; however, the SOX rallied .
380 370 360 350
A
2200 2150
NASDAQ NASDAQ
2100 2050
In Dec., the lower high (B) and relative weakness in the SOX made the bullish
2000 1950
run in the Nasdaq suspe
1900 1850 1800
These two cannot stay
1750 9 August
16
23
30
7 13 20 September
27
4 11 October
18 2 5
1 8 15 November
22 2 9
6 13 December
20 27
3 1 2005
out of sync for long!
Sector Analysis Gold/Silver Index (XAU)
At times, a commodity
Non-confirmation
and/or the underlying equities index will not confirm a new
Confirmed
high or low of the other.
Confirmed
A non-confirmation makes
Non-confirmation
the index or the commodity’s new high or low suspect.
Non-confirmation Gold
Confirmed Confirmed new highs and
Confirmed
lows suggest continuation of the commodity and the
19 9 7
Non-confirmation 1 99 8
1 9 99
2000
underlying equity index. 20 0 1
2 00 2
2003
2004
2
Sector Analysis Commodity and Underlying Non-confirmation
Oil Index
rm Co nfi
ed
The early steady rise in 750 700 650
500 450 400
Non-confirmation
C
the Oil Index and the Oil
600 550
Oil Services Index
crude was confirmed by
ed o n f irm
130 125
Services Index. In late 2004, the new highs in the Oil and Oil
120 115 110 105 100
Services Index was not confirmed by Crude Oil.
95 90 85 80 55
rm e d Co nfi
Crude Oil
50 45 40
Non-confirmation
35 30 25
A
M J J
A S
O
N
D
2 004
M
A M
J
J
A
S
O N
A non-confirmation of Crude suggests either Crude will move higher or the breakout in the Indices will fail.
Sector Analysis Crude Oil
55
Oil Services Index
750
50
700
45
650 600
40
550
35
500
30
450
25
400
20
350 15 300 10 250 95
96
97
98
99
00
01
02
03
04
95
96
97
98
99
00
1995
1997 1998 1999
01
02
03
04
2001 2002 2003 2004
High oil prices are bearish for industries whose
150
220 210 200 190 180 170 160 150 140 130 120 110 100 90 80 70 60 50 40 30 20
Airline Index
The rising price of oil is bullish for oil related stocks.
140 130 120
top expenses are oil related.
110 100 90 80 70
Airlines and Truckers.
60
AMEX Oil Index 1997 1998
1999 2000 2001 2002 2003 2004
50 40
Transport Index
Sector Analysis 435 430 425 420 415 410 405 400 395
Homebuilders Index
390 385 380 375 370 365 360 355 350
Rising yields is bearish for interest rate sensitive stocks.
A
4.65 4.60 4.55 4.50 4.45 4.40 4.35 4.30 4.25 4.20 4.15 4.10
10-Year 26 2 9 16 August Yields
4.05 4.00
B 23
30
7 13 20 September
27
4 11 October
18
25 1
Higher Low
8 15 November
22 2 9
6 Dec
3.95 3.90
Rising interest rates are bearish for home builders. At (A), the steady drop in yields confirmed the move higher in the sector. At (B), the higher low and breakout in yields confirmed the Double Top and break lower in the sector.
Sector Analysis 60
Lennar Homes
55
10-Yr. Note
Lower yields, bullish for home builders
50
In sync
45 40 35 30 25 20 15 10 5
1 9 98
19 9 9
2 0 00
2 00 1
2 0 02
20 0 3
2 0 04
19 9 8 1550
S&P 500
A weak U.S.$ also attracts foreign money to U.S. real estate
1500 1450 1400
1999
2 00 0
2 0 01
2002
2003
2004
Home builders will be influenced by the general market, but also by bond yields.
1350 1300 1250 1200 1150 1100 1050 1000
They can show relative strength or weakness depending on whether all markets are in sync or not.
950 900 850 800 750 1 998
1999
2000
2001
2002
2003
2 004
Lower yields and a higher stock market are bullish for home builders.
Sector Analysis While home building stocks
10-Yr. Yield
(A)
( B)
(D)
( C)
will be influenced by general
?
4.5
?
4.0
market trends, interests rates wil have a major influence. At (A) the sharp fall in the
3.5
3.0
( C)
Hovnanian (HOV)
(D )
50 45 40
( A)
( B)
Yr. Yield increases the bullish bias in Hovnanian. At (B), the sharp rise raised a more bearish bias.
35 30
At (C) the sharp rise was
25
bearish and HOV declined.
20 15 10 A S O N D 2003
A M J J A S O N D 2 004
A MJ J AS O N D2
At (D) rates were lower, then stable at a historical low level.
Tradable Instruments When Commodities Are Tren Futures and Trusts Futures on CRB Index and Goldman Sachs Commodity Index Holders/SPDRS/iShares
Stocks - Industry Steel (X, AKS, SCHN, STLD)
Mining – Gold (NEM, AEM, ABX, PDG, GFI, MDG, AU) Mining – Other (PD, AL, FCX, AA)
XLB – Materials SPDR
Paper (IP, WY, GP, BOW, TIN, BCC, LPX)
XLE – Energy SPDR
Fertilizer (POT, AGU)
GLD – Gold SPDR
Chemicals (DOW, APD, LYO, HPC, DD, ASH)
OIH – Oil Ser vices
Construction Materials (VMC, EXP, CX, TXI)
Commodities themselves YG – Gold Many other metals, meats, grains, etc. at www.cbot.com
Oil & Gas (AHC, BR, MRO, KMG, OXY) Energy Equipment & Services (BHI, SLB, CAM, WFT) Containers and packaging (SEE, SSCC, PKG) Grains (ADM, CAG, MGPI)
Sector Analysis 31
Basic Materials (XLB)
30
CRB Index
29 28
In sync
27 26 25 24 23 22 21 20 19 18 17
Relative Strength 2000
2001
2002
2003
16 200 0
2 0 04 1550 1500 1450 1400 1350 1300
200 1
2 002
20 03
2004
Basic material and commodity-related stocks will be influenced by the general market and by the CRB.
1250
S&P 500
1200 1150 1100 1050 1000 950
They can show relative strength or weakness depending on whether all markets are in sync or not.
900 850 800 750 2000
2 001
2002
2003
2004
Rising CRB and a higher stock market is bullish for basic materials.
Sector Analysis A
CRB Index
Failed Breakout
290
Phelps Dodge
285
280
275
Copper
270
When the CRB is weak, look to short bearish patterns related to commodity stocks
7 1 3 20 ptember
27
4 11 October
18
25 1
8 15 November
2 2 29
6 13 December
20 27
3
1 2005
Alcan
7 1 3 20 eptember
35.0 34.5
27
4 11 October
18 2 5 1
8 15 November
22 29
6 13 December
20 27
3
1 2005
22 29
6 13 December
20 27
3 1 2005
Ashland
34.0 33.5
Weakest
B
33.0 32.5 32.0 31.5 31.0 30.5
Aluminum
Chemicals
30.0 29.5
7 13 20 eptember
27 4 11 October
18 2 5 1
8 15 November
22 29 6 13 December
20 27
3 1 2005
7 1 3 20 eptember
27
4 11 October
18 2 5 1
8 15 November
Sector Analysis 3-Month Yields
(A)
(B)
U.S. Dollar This was an area of long-term support
2.3 2.2 2.1 2.0 1.9 1.8 1.7 1.6
Short-term yields were rising steady, which should have a positive effect on the
1.5 1.4 1.3
US Dollar and negative effect on Gold.
90 89 88 87 86 85 84 83 82 81 80
At (A), there was a minor move up in the Dollar which, along with the rising yields, was enough to affect
110
GOLD Index
105
Gold.
100 95 90 85 80 August
September
October
November
December
200
The next move up in the Dollar (B) brought the next drop in the Gold Index.
Sector Analysis DOW-30
Dow Theory
Dow Theory states that to have a 11500
11000
10500
true bull market, the Dow Industrials
and Transports must move up together. Industrial companies manufacture the goods; the Transports move them.
10000
Non-confirmation/ Bearish Divergence
Apr May Jun Jul
3800 3700 3600 3500 3400 3300 3200 3100 3000 2900 2800 2700 2600 2500 2400 2300 2200
Transports ar
Thus, the theory is that if they are
Aug Sep O ct Nov D ec 2000
Mar
doing poorly, it is an indicator of economic weakness (and vice versa). The Dow Transports were giving a bearish signal in 1999 and early 2000. As the Dow rallied to a new high in 2000, the Transports failed to move up at all, which was a bearish divergence.
Sector Analysis DOW-30
Dow Theory
10800 10700 10600 10500 10400 10300 10200
The strength in Transports made us more bullish at these points, particularly with bullish Sentiment
Transports t
Nov Dec 2004
Mar
Apr May Jun Jul
Aug S ep Oct
10100 10000 9900 9800 9700 9600 9500 3500 3450 3400 3350 3300 3250 3200 3150 3100 3050 3000 2950 2900 2850 2800 2750 2700
The Dow Transports were giving bullish signals in 2004 as they advanced to new highs. Dow Theory would have flagged a bearish warning because of the Dow’s failure to make new highs; however, the message of the Transports was still bullish, giving us a bias to buy compelling long setups. Transportation stocks move goods, so if they are doing well, it is an excellent indicator of economic strength.
Sector Analysis Relative Strength at Early Expansion Strength in retailers is a bullish indicator for the market
Retail jumping from the weakest to the strongest showed strong consumer confidence and spending.
Investments in small caps shows investor confidence.
Strong transports are a good sign for the economy, since it is needed to move produced goods For example, FDX. Transports, Green Retail, Red Russell 600 Small Cap, Black M A M J J A S O N D 2003 M A M S&P, Purple
JJA
S O N
All support a bullish bias for the S&P 500
Inter-Market Review and Developing a Trade Bias
Inter-Market Review and Bias Initially, raising rates are not bad. They indicate that the economy is doing well. Equity markets can rise while short-term rates are rising. If long-term rates are going up with short-term rates, it is eventually bearish. Long and short rates coming together is not bad until they get too close or invert. Rising commodity prices and rising long- and short-term interest rates are eventually bearish for stocks, and vice versa. Rising commodity prices are bearish for the U.S. Dollar, and vice versa. The direction of the U.S. Dollar has implications for the economy, which affects the stock market, but its direction alone is not enough to be bullish or bearish. It’s the bond market’s opinion, combined with the above that will guide us.
Inter-Market Review and Bias Bia Commodities and Interest: Flag Danger and Opportunity! 3-Month, Red 5-Year, Purple 30-Year, Green
10 9 8
Inversion 5- & 30-
By early 1973, the 3-Month Yield moved above the 5- and
7
30-Year. Combined with rising
6 5
commodities, a bearish signal.
4
Inverted
120 110 100
S&P 500
90 80
S&P 500
The bear market ended in late 1974 when yields r everted into a normal alignment.
70
2x Bottom
60
CRB CRB 200
Breakdown
150
Larger market corrections have occurred when commodity prices and interest rates both advanced, and/or
100 1972
197 3
19 74
1975
1
became inverted.
Inter-Market Review and Bias 5- & 30-Yr. reverted to normal
6
A
5
In 2002, the historically wide sp read be tween long- and short
4 3
term yields provided the
2
monetary liquidity to support a bullish bias for stocks. 1500 1
30-Year, Green 5-Year, Purple 3-Month, Red
1400 1300 1200 1100 1000
S&P 500
900 800 290 280 270 260 250 240 230 220 210 200 190 180
A CRB 2001
2002
2003
2004
2
Commodities started rising in 2002 (demand), indicating the economy was improving. Sideways to declining longterm yields at (A) suggested there was low expectations of inflation even though the CRB was rising.
U.S. $ Bias Based on CRB and Yields 125
U.S. Dollar
(A )
(F)
(D)
120 115 110
(B)
(C)
105 100
At (A) commodities were rising (bearish), rates were declining, then flat (bearish). Dollar down.
95 90 85 80
CRB Index (B)
(F)
(D)
(C)
(E) (A )
290 280 270 260 250 240 230 220 210 200 190 180
3-Month Rates
At (B) commodities were declining (bullish), rates falling (bearish). Dollar neutral. At (C) commodities were rising (bearish), rates were rising (bullish). Dollar neutral. At (D) commodities were falling most of the time (bullish), rates were steady at higher levels, then higher
9
(B)
8
(D) (E)
(C)
7
(F)
3
When commodities and short-term rates are in opposition, the U.S. $ trend is decisive. 87
88
5 4
(A)
86
6
89
90
91
92
93
94
95
96
97
98
99
00
01
2 1 02
03
04
(bullish). Dollar up. At (E), commodities were rising (bearish), rates were rising (bullish). Dollar neutral. At (F) commodities were rising (bearish), rates were falling (bearish). Dollar down.
Inter-Market Review and Bias 2-YrY. ield
23.2-YrN. ote 3.1 3.0 2.9
A
2.8 2.7 2.6 2.5 2.4 2.3 2.2 2.1 2.0
Yields rose from 1.4 % to 3.2% in a few months
1.9 1.8 1.7 1.6 1.5
Daily 04
Ma r
1.4 1.3 Apr
May J un
Jul
Aug
Sep Oct
Nov
Dec 20
Weekly 2000
2001
2002
2003
2004
You might be tempted to take advantage of the much higher short-term yields that were available, which would be okay, if you did it properly. At (A), the 2-Yr. Bond turned lower, so while you would benefit from the higher current yield, you would lose principal as prices declined.
Holding a bond to maturity, rather than buying a bond fund, avoids principal risk
Inter-Market Summary and Bias MarketEvent
A n a l ys i s
Commodities turn up from a downtrend
Rising commodities are considered inflationary (bearish), but initially it indicates increased demand (growth, bullish)
Commodities turn down from an uptrend
Falling commodities are considered non-inflationary, but initially it indicates decreased demand (contraction, bearish)
Long-term yields turn up from a downtrend or base
Rising long-term yields are viewed as bearish, but initially it indicates increased demand-growth bullish.
Long-term yields turning down from an uptrend or base
Falling long-term yields are viewed as bullish, but initially it indicates decreased demand-growth.
Short-term yields turn up from a downtrend or base
Rising short-term yields are viewed as bearish, but initially it indicates the need to slow growth, bullish.
Short-term yields turning down from an uptrend or base
Falling short-term yields are viewed as bullish, but initially it indicates the need to stimulate growth, bearish.
What Is The Trend and How Long Has It Been Trending? Inter-MarketEvent
Inter-MarketAnalysis
CM
LTY
STY
Rising CM bearish for U.S.$, LTY-STY narrowing, so check spread
CM
LTY
STY
Rising CM bearish for U.S.$, LTY & STY rising, so inflation concerns
CM
LTY
STY
Falling CM, rising STY bullish for U.S.$, inflation concerns low. EURO?
CM
LTY
STY
Falling CM and STY neutral for U.S.$, LTY some inflation concerns
CM
LTY
STY
Rising CM and falling STY bearish for U.S.$, LTY inflation concerns
Higher or lower inflation is not necessarily good or bad. The important thing is what the Fed and Bond Market believe about it. Monitoring Gold, the U.S.$ and long-term bonds is a means of assessing the effectiveness of the Fed’s actions. Is Fed raising or lowering short-term rates? If (a) Gold begins to stabilize or move lower, and ( b) the U.S. $ begins to stabilize or rise, and (c) long-term bond yields stabilize or move lower, these show approval of the effects of the Fed’s actions (rising rates) against inflation.
Inter-Market with Breadth and Sentiment 5.5
McClellanOscillator
5.0 4.5
150 100 50 0
4.0 3.5
(C)
-50 -100 -150 -200 -250
3.0 2.5 2.0
30-Year, Green 5-Year, Purple 3-Month, Red
-300 -350 -400
1.5 1.0
(A)
S&P 500
(B)
1190 1180 1170 1160 1150 1140 1130 1120 1110 1100 1090 1080 1070 1060
10-MANYSETRIN
350 300 250 200
2004
Mar
A pr M a y
J ul
Aug S ep Oct N ov D
5-Day Equity P/C Ratio
2004
Mar
A p r Ma y J u n J u l
A u g Se p O c t
N ov D
AAII Bull Ratio
0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0.75 0.80
O
0.85 0.90
20 04
M ar A p r M ay
Ju l A u g S e p Oc t N o v D
20 04
M A
M J
J
A S
O
N D
290 285
At (A), the S&P blasted to new highs
280 275
CRB Index (B) breaking to a new high
270 265 260
CRB 2004
M
255 A
M
J
J
A
S
O N
D
Yields (C) slowly beginning to move higher Short-term Breath and Sentiment indicators
Concluding Thoughts You now have a solid foundation of the inter-relationships between Bonds, Commodities and Currencies. Now you can interpret comments by the media with the confidence to know what is pertinent and what is noise. You now understand what has the potential to set up a long-term reversal points in the market.
Your understanding of this information, coupled with the other components of The Pristine Method®, empowers you to be objective and self-reliant. Get the pertinent data to setup and interpret in a routine manner based on your time frame and Trading Plan (www.pinnacledata.com).
Concluding Thoughts At this point, you have the pertinent information that makes intermarket analysis valuable. It’s up to you to work with the material and now make it yours, in accordance with your trading style. You do not need to be an economist or analyze the vast amount of information. With this information, you should be able to analyze inter-market relationships and make intelligent trading decisions. Define an opportunity where the odds are in your favor, then have the discipline to follow your trading and money management rules.
In closing, we at Pristine wish you great success!
