If You Can't Be With The Stock You Love, Love The Stock Your With!! (ci)
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Industrial Metals and Bonds
Not all commodities are created equal. In particular, oil is prone to supply shocks. Unrest in oil producing countries or regions usually causes oil prices to surge.
Bonds benefit from a decline in commodity prices because this reduces inflationary pressures. Stocks can also benefit from a decline in commodity prices because this reduces the costs for raw materials.
Countries with weak economies and big debt burdens are subject to weaker currencies. A rising Dollar puts downward pressure on commodity prices because many commodities are priced in Dollars, such as oil.
What are the effects of a rising Dollar? A countries currency is a reflection of its economy and national balance sheet. Countries with strong economies and strong balance sheets have stronger currencies.
Obviously, a big advance in commodities would be bearish for bonds. By extension, a weak Dollar is also generally bearish for bonds. A weak Dollar acts an economic stimulus by making US exports more competitive. This benefits large multinational stocks that derive a large portion of their sales overseas.
Dollar and Commodities
While the Dollar and currency markets are part of intermarket analysis, the Dollar is a bit of a wild card. As far as stocks are concerned, a weak Dollar is not bearish unless accompanied by a serious advance in commodity prices.
The list below summarizes the key intermarket relationships during a deflationary environment.
An INVERSE relationship between bonds and stocks
A POSITIVE relationship between interest rates and stocks
An INVERSE relationship between commodities and bonds
A POSITIVE relationship between commodities and interest rates
A POSITIVE relationship between stocks and commodities
An INVERSE relationship between the US Dollar and commodities
A rise in bond prices and fall in interest rates increases the deflationary threat and this puts downward pressure on stocks. Conversely, a decline in bond prices and rise in interest rates decreases the deflationary threat and this is positive for stocks.
Obviously, deflationary forces change the whole dynamic. Deflation is negative for stocks and commodities, but positive for bonds.
The intermarket relationships during a deflationary environment are largely the same except for one. Stocks and bonds are inversely correlated during a deflationary environment.
The subsequent threat of global deflation pushed money out of stocks and into bonds. Stocks fell sharply, Treasury bonds rose sharply and US interest rates decline.
The subsequent threat of global deflation pushed money out of stocks and into bonds. Stocks fell sharply, Treasury bonds rose sharply and US interest rates decline.
The subsequent threat of global deflation pushed money out of stocks and into bonds. Stocks fell sharply, Treasury bonds rose sharply and US interest rates decline.
Asian central bankers raised interest rates to support their currencies, but high interest rates choked their economies and compounded the problems.
Deflationary Relationships
Murphy notes that the world shifted from an inflationary environment to a deflationary environment around 1998. It started with the collapse of the Thai Baht in the summer of 1997 and quickly spread to neighboring countries to become known as Asian currency crisis.
As interest rates fall and the economy strengthens, demand for commodities increases and commodity prices rise. Keep in mind that an "inflationary environment" does not mean runaway inflation. It simply means that the inflationary forces are stronger than the deflationary forces.
In an inflationary environment, stocks react positively to falling interest rates (rising bond prices). Low interest rates stimulate economic activity and boost corporate profits.
This means they both move in the same direction. The world was in an inflationary environment from the 1970's to the late 1990's. These are the key intermarket relationships in a inflationary environment:
A POSITIVE relationship between bonds and stocks
An INVERSE relationship between interest rates and stocks
Bonds usually change direction ahead of stocks
An INVERSE relationship between commodities and bonds
A POSITIVE relationship between commodities and interest rates
A POSITIVE relationship between stocks and commodities
Commodities usually change direction after stocks
An INVERSE relationship between the US Dollar and commodities
Inflationary Relationships
The intermarket relationships depend on the forces of inflation or deflation. In a "normal" inflationary environment, stocks and bonds are positively correlated.
There are clear relationships between stocks and bonds, bonds and commodities, and commodities and the Dollar. Knowing these relationships can help chartists determine the stage of the investing cycle, select the best sectors and avoid the worst performing sectors. Much of the material for this article comes from John Murphy's book and his postings in the Market Message at Stockcharts.com.
In his classic book on Intermarket Analysis, John Murphy notes that chartists can use these relationships to identify the stage of the business cycle and improve their forecasting abilities.
Intermarket analysis is a branch of technical analysis that examines the correlations between four major asset classes: stocks, bonds, commodities and currencies.
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You have a link for that news by chance?
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Higher prices led to more news and more news led to more investment money. A feedback loops evolved where price increases were feeding more price increases. Shiller calls these mechanisms naturally occurring Ponzi schemes because they feed on the perception of prior success.
Third, the consistent rise in stock prices provided a feedback loop that kept public attention on stocks. As the media reported the rise in the stock market, new money found its way into the stock market and pushed prices even higher.
The media fed this infatuation with increased coverage. Dinner party conversations invariably turned to the stock market. Stock tips and advice were also readily shared among acquaintances.
Second, as inferred above, Shiller asserts that public attention to the stock market hit new levels in the 1990's. This heightened awareness made more money available for stocks.
Subsequent editions have appeared in 1998, 2002 and 2007. Stocks indeed performed well from 1995 until 2000, when the S&P 500 peaked around 1550.
By the late 1990's stocks were considered a long-term investment that could not go wrong. Jeremy Siegel first published Stocks for the Long Run in 1994.