What is Intermarket Analysis?
Intermarket analysis is the study of multiple asset classes in a variety of markets in nations around the globe. In essence intermarket analysis examines the correlations between the four major asset classes: stocks, indices, commodities, and currencies. Intermarket analysis purports that there are clear relationships between these asset classes that need to be factored in when trading.
The Importance of Maintaining a Diversified Portfolio
Financial experts sing the praises of a diversified portfolio. But maintaining a diversified portfolio requires great discipline, especially when it comes to trading a number of different asset classes. Understanding these intermarket relationships is essential for traders who wish to maintain a diversified portfolio and mitigate risk. By following multiple markets, an investor gets the “bigger picture” and is able to recognise significant market and economic changes.
Understanding The Forces Of Inflation and Deflation
Intermarket analysis depends largely on the forces of inflation or deflation. In a “normal” inflationary environment, stocks and indices are positively correlated. This means that they tend to move in much the same direction.In an inflationary environment, stocks tend to react positively to falling interest rates. Low interest rates stimulate economic activity and boost corporate profits.Global deflation however, tends to push money out of stocks causing them to record shap losses.
An Intermarket Example: Dollar and Commodities
Perhaps the best example of intermarket analysis comes from the way the USD can affect assets of a different class. As a rule of thumb, a weak Dollar acts an economic stimulus by making US exports more competitive. Commodities such as oil and gold become more attractive to foreign investors as they are cheaper to import. This can drive commodity prices higher while also benefiting large multinational stocks that derive a large portion of their sales overseas. On the flipside, a rising Dollar puts downward pressure on commodity prices because many commodities are priced in Dollars, such as oil.
Intermarket Analysis is a valuable tool for long-term analysis as these relationships generally work over longer periods of time. We can see how an intermarket perspective can be used as an analytical tool and how it provides a much broader picture when compared to a single-market outlook.
Sources: Stockcharts, Investopedia