ffirs.qxd 10/31/03 12:31 PM Page iii Intermarket Analysis Profiting from Global Market Relationships JOHN MURPHY John Wiley & Sons, Inc ffirs.qxd 10/31/03 12:31 PM Page iii ffirs.qxd 10/31/03 12:31 PM Page i Intermarket Analysis ffirs.qxd 10/31/03 12:31 PM Page ii 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 For a list of available titles, please visit our Web site at www.WileyFinance.com ffirs.qxd 10/31/03 12:31 PM Page iii Intermarket Analysis Profiting from Global Market Relationships JOHN MURPHY John Wiley & Sons, Inc ffirs.qxd 10/31/03 12:31 PM Page iv Copyright © 2004 by John Murphy All rights reserved Some of the figures in Chapters 1, 2, and 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 www.copyright.com 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: permcoordinator@wiley.com 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 www.wiley.com ISBN: 0-471-02329-9 Printed in the United States of America 10 ffirs.qxd 10/31/03 12:31 PM Page v To Anne, a great poet and to Tim, a great brother ffirs.qxd 10/31/03 12:31 PM Page vi ftoc.qxd 10/31/03 12:35 PM Page vii Contents Acknowledgments ix Introduction to Intermarket Analysis xi A Review of the 1980s 1990 and the First Persian Gulf War 17 The Stealth Bear Market of 1994 33 The 1997 Asian Currency Crisis and Deflation 51 1999 Intermarket Trends Leading to Market Top 65 Review of Intermarket Principles 81 The NASDAQ Bubble Bursts in 2000 97 Intermarket Picture in Spring 2003 115 Falling Dollar During 2002 Boosts Commodities 131 10 Shifting from Paper to Hard Assets 145 11 Futures Markets and Asset Allocation 159 12 Intermarket Analysis and the Business Cycle 179 13 The Impact of the Business Cycle on Market Sectors 199 14 Diversifying with Real Estate 217 15 Thinking Globally 235 Appendix 247 Index 263 vii ftoc.qxd 10/31/03 12:35 PM Page viii 16_appendix_murphy.qxd 10/31/03 12:28 PM Page 256 256 APPENDIX Figure A.5 The 10-year T-note yield is testing the three-year down trendline extending back to the start of 2000 A close over that trendline would confirm that longterm rates have bottomed Over the prior three years, falling bond yields were a barometer of global economic weakness Rising bond yields carry a more optimistic message for the economy over the short run Over the long haul, rising rates could threaten an economic recovery The jump in bond yields also suggests that deflationary pressures are easing 70.0 10-Year T-Note Yield 67.5 THE 10-YEAR T-NOTE YIELD IS TESTING A THREE-YEAR DOWN TRENDLINE 65.0 62.5 60.0 57.5 55.0 52.5 50.0 47.5 45.0 42.5 40.0 37.5 35.0 32.5 © StockCharts.com 2003 Oct Apr Jul Oct 30.0 Apr Jul Oct Apr Jul Oct Apr Jul Oct Apr Jul Oct 16_appendix_murphy.qxd 10/31/03 12:28 PM Page 257 257 Appendix Figure A.6 The Dollar Index peaked at the start of 2002 and broke a seven-year up trendline at the end of that year The breakdown in the U.S currency gave a big boost to commodity markets (gold in particular) At the start of the fourth quarter 2003, the dollar is threatening the low it had formed during second half of 1998 During the first week of October, a rebound off that low caused some profit-taking in the gold market The major trend of the dollar, however, is still down 125 US Dollar Index 120 115 110 105 100 95 THE DOLLAR INDEX IS TESTING ITS 1998 BOTTOM 90 85 © StockCharts.com 2003 1995 1996 1997 1998 1999 2000 2001 2002 2003 80 16_appendix_murphy.qxd 10/31/03 12:28 PM Page 258 258 APPENDIX Figure A.7 Gold broke through the $325 level at the end of 2002, which exceeded the previous peak reached during 1999 That launched a new bull market in gold (and gold stocks) After briefly hitting a seven-year high, gold entered a downside correction at the start of October 2003 A surprisingly strong jobs report on October 3, 2003 gave a boost to the stock market and the dollar That caused profit-taking in gold and gold shares The early 2003 pullback in bullion stopped at the original breakout point at $325, which is the new floor under the gold market The major trend of gold is still up 420 Gold - Continuous Contract GOLD IS IN A DOWNSIDE CORRECTION AFTER HITTING A SEVEN-YEAR HIGH 400 380 360 340 MAJOR SUPPORT LEVEL 320 300 280 260 © StockCharts.com 2003 1995 1996 240 1997 1998 1999 2000 2001 2002 2003 16_appendix_murphy.qxd 10/31/03 12:28 PM Page 259 259 Appendix Figure A.8 The Japanese yen surged to a three-year high versus the dollar in midSeptember 2003 That was the result of a G7 call for flexible exchange rates The immediate result was an explosive upmove in the Japanese yen The rising yen was more reflective of a strengthening Japanese economy and strong money flows into Asian markets It raised fears, however, that Japan might cut back on purchases of U.S Treasuries, which could result in higher long-term interest rates in the states The G7 message left little doubt that the United States wanted a weaker dollar Japanese Yen MA(40) © StockCharts.com 2003 0.96 0.94 THE JAPANESE YEN HAS CLIMBED TO A THREE-YEAR HIGH VERSUS THE DOLLAR 0.92 0.90 0.88 0.86 0.84 0.82 0.80 0.78 0.76 0.74 Oct Apr Jul Oct Apr Jul Oct Apr Jul 16_appendix_murphy.qxd 10/31/03 12:28 PM Page 260 260 APPENDIX Figure A.9 The Nikkei 225 rose to the highest level in fourteen months during September 2003 Its move over the 40-week moving average during June was a chart sign that the trend was turning higher The ratio of the Nikkei divided by the S&P 500 started rising in April, which meant that Japanese stocks were outperforming U.S stocks Long-term interest rates in Japan started jumping during the summer, which reflected a move out of Japanese bonds and into stocks It may have also been a strong sign that deflationary trends were easing in Japan and elsewhere on the globe Tokyo Nikkei Average MA(40) © StockCharts.com 2003 12500 12000 THE JAPANESE STOCK MARKET WAS THE WORLD'S STRONGEST MARKET DURING THE THIRD QUARTER OF 2003 11500 11000 10500 10000 9500 9000 8500 8000 Nikkei / S&P 500 Ratio EMA(20) IT'S BEEN STRONGER THAN THE U.S MARKET SINCE APRIL 2003 7500 13 12 11 10 S O N D F M A M J J A S O N D F M A M J J A S 16_appendix_murphy.qxd 10/31/03 12:28 PM Page 261 261 Appendix Figure A.10 Industrial Metals peaked during 1997 with the beginning of the Asian currency crisis, and signaled the start of global deflationary problems and economic weakness Industrial Metals have broken a six-year down trendline That’s a good sign for global economies It’s bad news for bonds, however, since rising Industrial Metals are usually associated with rising long-term interest rates Rising Industrial Metals also suggest that global deflationary problems that started in 1997 have run their course That means that deflation has given way to reflation Industrial Metal Prices - Goldman Sachs Commodity Index 195 190 INDUSTRIAL METALS HAVE RISEN ABOVE A SIX-YEAR DOWN TRENDLINE WHICH IS A SIGN OF GLOBAL ECONOMIC RECOVERY 185 180 175 170 165 160 155 150 145 140 135 130 125 © StockCharts.com 2003 1997 1998 120 1999 2000 2001 2002 2003 16_appendix_murphy.qxd 10/31/03 12:28 PM Page 262 17_index_murphy.qxd 10/31/03 12:29 PM Page 263 Index smaller stocks lead at bottoms, 209 technology leadership is a good sign, 204–205 transportation leadership, 206–208 yield curve another view of, 214–215 flattens during 2003, 213–214 overview, 212–213 A Asian currency crisis and deflation in 1997 See 1997 Asian currency crisis and deflation B Bearish divergence, 21 Business cycle, impact on market sectors See also Intermarket analysis and the business cycle consumer spending, relative strength of, 202–203 cyclicals starting to outperform staples, 208 economic cycle, different view of (Stovall’s circle), 200–201 interest rate trends, 212 Nasdaq leads market higher during 2003, 205–206 retail buying, 203–204 sector leadership moves to consumers and technology, 201–202 sector rotation within business cycle, 199 model, 210 supporting data, 210–212 in 2000 favored contraction, 199–200 during 2003 suggest early expansion, 201 C CMR (Morgan Stanley Consumer Index), 61, 107 Commodity/bond ratio, 95 Commodity divergence, 135 CRB (Commodity Research Bureau)/bond ratio, 49 CRB (Commodity Research Bureau) index, 1–2, 33–34 description of, 33–34 industrial versus agricultural markets, 34–37 rise in early 1993, 34 CYC (Morgan Stanley Cyclical Index), 61, 208 Cyclical bear markets, 150 Cyclical stocks, 60 D Davis, Ned, 151 Decoupling, definition of, 52 Dollar bloc countries, 235 263 17_index_murphy.qxd 10/31/03 12:29 PM Page 264 264 INDEX Dollar, fall during 2002 boosts commodities Asian deflation pulls U.S rates lower, 138 bonds and commodities decouple, 132–133 commodities divergence, 134–135 gain from battle against deflation, 142 inflation, 131 prices and bond yields normally trend together, 137 dollar peak coincides with commodity bottom, 132 dollar top leads to new bull market in gold, 142–143 global bear market, 139–140 industrial metals and interest rates trend together, 135–136 Japan pulling world markets lower, 140–141 possible swing back to hard assets See Paper to hard assets, shifting from U.S stocks and interest rates fall together, 141–142 war premium pushes oil higher, 133–134 Dollar Index, 124 built-in asset allocation model, 165–166 charts comparing futures markets, 166–167 commodities versus bonds, 161–162 commodity futures as an asset class, 169 currencies, treating as an asset class, 171–172 Dow/gold ratio, 162–163 futures portfolios correlate poorly with bonds and stocks, 168–169 gold/currency ratios are rising, 174 gold is stronger than all major currencies, 176 gold measured in foreign currencies, 173–174 impact of a falling dollar, 172 including commodities and currencies, 163–165 pushing the efficient frontier, 169–171 relative strength analysis among asset classes, 159 role of futures in asset allocation, 165 summary, 176–178 using managed futures accounts, 167–168 E G Efficient frontier, 169–170 GCSI (Goldman Sachs Commodity Index), 40 Global divergence, 22 Global thinking all markets are related, 235–236 bonds and stocks decouple, 239 decade after market booms is not very good, 240–243 emerging markets, 237–238 F First Persian Gulf War See 1990 and first Persian Gulf War Fisher, Kenneth, 225 Futures markets and asset allocation bonds versus stocks, 159–161 17_index_murphy.qxd 10/31/03 12:29 PM Page 265 Index global trade increases impact of exchange rates, 236–237 intermarket implications for technical analysis, 243 intermarket model is not static, 238–239 intermarket work is an evolutionary step, 244–245 more intermarket emphasis on sector work, 238 need for better peripheral vision, 244 still a lot to learn, 245 why we need to study history, 239–240 Gold Index (XAU), 125–126 Goldman Sachs Commodity Index (GSCI), 40 Gordon, Ian, 196–197 Group rotation, 71 H Hard assets, shifting to from paper assets See Paper to hard assets, shifting from Head and shoulders bottom, Head and shoulders top, 124 I Inflation-sensitive stocks, 49 Interest rate-sensitive stocks, 37, 49 Intermarket analysis See also Global thinking business cycle and See Intermarket analysis and the business cycle picture in spring 2003 See Intermarket picture in spring 2003 principles See Intermarket principles, review of 265 simultaneous analysis of four financial markets, 5–6 Intermarket analysis and the business cycle bonds are the focal point, 182–183 bonds as a leading economic indicator, 185 business cycle explains intermarket rotation, 180–181 chronological sequence of bonds, stocks, and commodities, 181–182 four-year business cycle, 179–180 Journal of Commerce (JOC) Index, 186 lessons of 2000, 184–185 market rotations during the 1920s and 1930s See Market rotations during the 1920s and 1930s six stages of the business cycle, 183–184 stocks and commodities as leading indicators, 185–186 2001 recession predicting, 186–187 three markets followed proper rotation for tops, 187 Intermarket picture in spring 2003 bond and stock prices trend in opposite directions, 119–120 bonds and commodities trend in opposite directions, 116 commodities follow lead of stocks, 117–118 dollar falling dollar is bullish for gold, 124–125 letting it fall, 128–129 major top in the making, 124 Federal Reserve discovers deflation, 127–128 17_index_murphy.qxd 10/31/03 12:29 PM Page 266 266 Intermarket picture (continued) gold falling dollar is bullish for gold, 124–125 falling stocks are good for gold, 122–123 flight to, 115 gold stocks shine, 125–127 September 11 reversals, 116–117, 120–122 stocks lead commodities higher, 118–119 Intermarket principles, review of advantages of charting, 87–88 asset allocation strategies, 82 basic premise, 82–83 currency trends, global impact of, 89–90 dollar impact on drug stocks, 90–91 impact on multinationals, 90 McDonalds and Procter & Gamble profit from weak dollar, 90 role of, 89 small stocks are domestic, 91–92 weak dollar helps service stocks, 92 economic forecasting, 88 economic lessons, 87 emphasis on sector work, 82 evolutionary step in technical analysis, 81–82 global markets, 83 global sector trends, 83–84 Japan effect overrides Federal Reserve, 86–87 Japan’s effect on U.S markets, 84–86 markets anticipate economic trends, 88–89 overview, 81, 93–95 technical nature of intermarket analysis, 87 INDEX Intermarket trends leading to market top in 1999 See 1999 intermarket trends leading to market top Inverted yield curve, 97, 212 Iraq crises 1990, 12, 17–18, 22–23 See also 1990 and first Persian Gulf war 2003, 12 J January Barometer, 100 Japan effect on U.S markets, 84–86 never recovers from first Persian Gulf war, 32 overriding Federal Reserve, 86–87 pulls world markets lower in 2002, 140–141 real estate collapsed two years after stocks, 233 JOC-ECRI Index (Journal of Commerce–Economic Cycle Research Institute Industrial Price Index), 37–39 JOC (Journal of Commerce) Index, 186 K Kondratieff, Nikolai, 195 Kondratieff wave, 195–197, 225 L Lintner, John, 167 Logarithmic price scale, 148 Long, Clarence, 225–226 Long Cycle, 225–226 Long Wave Analyst, The, 196 17_index_murphy.qxd 10/31/03 12:29 PM Page 267 Index M Managed futures accounts, 167–168 Market rotations during the 1920s and 1930s Kondratieff wave, 195–197 lessons of long cycles, 194–195 overview, 189 rotating asset classes over decades, 194 sequence of events commodities peaked in 1920, 189–190 bonds bottomed during 1920, 190 stocks bottomed during 1921, 190 bonds turned down in 1928, 190–191 bonds and stocks decoupled in 1929, 191 commodities plunged in 1929, 191 stocks and commodities bottomed together in early 1930s, 191–192 reflating during the 1930s, 192 bond yields spiked up temporarily in 1931, 193 stocks and commodities completed bottoms in early 1940s, 193–194 Market sectors, 71 Morgan Stanley Consumer Index (CMR), 61, 107 Morgan Stanley Cyclical Index (CYC), 61, 208 N Nasdaq bubble bursts in 2000 inverted yield curve implies economic weakness, 97–98 lessons of 2000, 113 267 overview, 97 sector rotation within economic cycle, 109–111 seeing things as they happen rather than with hindsight, 98–99 sequence of events January 30 yield curve inversion, 99 1969 all over again?, 99–100 January lows broken, 100–101 April 15, 2000, Nasdaq breaks moving average line, 102 April 15, 2000, NYSE fails a test of highs, 102 cash is good, 101 real estate funds (REITs) hold up, 103–104 April 21, 2000, economic slowing, 105 copper and long rates peak together, 105 economic weakness favors consumer staples, 107 consumer staples start to outperform, 107–108 things could not be better, 108 August 11, 2000, shift to value, 108–109 November 10, 2000, slowing economy, 112–113 use of sector rotation diagram, 113 warning signs, 98 why it is bad when energy and consumer staples are strong, 111–112 Neckline, Negative divergence, 18 New economy technology stocks, 67 1920s and 1930s, market rotations during See Market rotations during the 1920s and 1930s 17_index_murphy.qxd 10/31/03 12:29 PM Page 268 268 1980s, review of overview, sequence of events commodities peak in 1980, 2–3 dollar bottoms in 1980, bonds bottom in 1981, stocks bottom in 1982, interrelationship of currencies, commodities, bonds, and stocks, 5–6 stock market crash in 1987 See Stock market crash of 1987 global linkage examples following stock market crash, 12 delay in dollar’s impact, 12, 14–15 end of decade, 15–16 1990 and first Persian Gulf war comparisons between 2003 and 1991, 31–32 Japan never recovers, 32 overview, 17–18 sequence of events bonds turn down in early 1990, 18–19 CRB Index of commodity markets rises in early 1990, 19–20 bonds and stocks diverge, 20–21 global markets don’t confirm U.S rally, 21–22 Iraqi invasion of Kuwait, 22–23 oil and gold soar, 24–25 markets reverse at start of war, 25–29 divergence between oil and oil shares, 29 importance of $40 oil, 29–30 intermarket lessons, 30–31 1994, stealth bear market of See Stealth bear market of 1994 INDEX 1997 Asian currency crisis and deflation, 51 1997 and 1998 only a dress rehearsal, 53 bonds and stocks diverge in 1998, 58–60 bonds and stocks start to decouple, 52 bonds versus stocks, 57–58 commodities versus bonds, 56–57 consumer versus cyclical stocks, 60 CRB/bond ratio and sector rotation, 60 CRB/bond ratio collapses during 1997, 60–61 deflation scenario, 52–53 dollar versus commodities, 54–55 Hong Kong and industrial metals peak together, 56 intermarket lessons of 1997 and 1998, 64 intermarket picture during 1997 and 1998, 53–54 overview, 51 plotting ratio of two competing sectors, 63–64 relative strength analysis, 61–63 1999 intermarket trends leading to market top Australian dollar and commodity prices, 79–80 commodities and interest rates trend together, 67 commodities jump in start of 1999, 67 financial stocks lose favor during 1999, 73–74 global influences, 77–78 Hong Kong and semiconductors, 78–79 impact of rising interest rates on stocks, 70 17_index_murphy.qxd 10/31/03 12:29 PM Page 269 269 Index industrial commodities and oil bottom, 68 intermarket sector effect, 71 NYSE advance-decline line falls in 1999, 70 rising crude oil good for oil shares, 71–72 sector influences, 74–77 sector rotation and the economy, 77 transportation stocks fall hard, 72–73 1998 trends reversed in 1999, 65–67 traditional markets, not many alternatives in, 156 using futures market, 154, 156 why 2003 was not a replay of 1991, 149 Persian Gulf Wars first, 12, 17–18, 22–23 See also 1990 and first Persian Gulf War second, 12 Portfolio insurance, Presidential cycle, 179 Pring, Martin J., 181, 183–184 Program trading, O Old economy stocks, 67 P Paper to hard assets, shifting from China not affected by dollar moves, 154 commodities outperform stocks for first time in 20 years, 148–149 commodity currencies rally, 154 commodity-related stocks, 156–157 cyclical versus secular trends, 150–151 falling dollar hurts global markets, 153–154 gold breaks 15-year resistance line, 145–146 gold comes back into favor, 145 gold turns up as stocks turn down, 146–148 historical research on cyclical bull markets, 151–152 overview, 144 rising currency markets, 152 secular bear market in stocks is good for gold, 152 R Real estate, diversifying with comparison to other cycles 1930s, 225–226 history since 1940, 226 stock market and interest rates, 226–227 decoupling from market during 1999, 228–229 housing stocks link to interest rates, 229 market rotation during 2000, 230–231 relinking with stock market, 231–232 Fed’s deflation fight boosts housing stocks, 232 housing tradeoff, 232 Japanese real estate collapsed two years after stocks, 233 overview, 225 cycle has been different, 217–218 housing is interest rate-sensitive, 223 location is everything, 217 long cycle in real estate activity, 225 real estate does not always follow inflation, 224 17_index_murphy.qxd 10/31/03 12:29 PM Page 270 270 Real estate (continued) real estate does not always follow interest rates, 224 real estate does not always follow stocks, 224–225 Real Estate Investment Trusts (REITs) change during summer of 2002, 220 peak in 2002 as market bottoms, 221–222 role reversals in 2000, 218–220 turn up as Nasdaq peaks, 218 underperform after summer of 2002, 222–223 Right shoulder, 29 S Sectors, market, 71 Shane, Matthew, 236 Single market analysis, 81 Stealth bear market of 1994 bonds and stocks rise together until 1998, 49–50 bonds peak ahead of stocks, 41–43 CRB/bond ratio, 49 CRB index description of, 33–34 industrial versus agricultural markets, 34–37 rise in early 1993, 34 favorable trends from 1990 through 1993, 33 gold and oil, importance of, 39–40 Goldman Sachs Commodity Index (GSCI), 40 intermarket picture reverses in 1995, 46–48 Journal of Commerce (JOC)–Economic Cycle Research Institute (ECRI) Industrial Price Index, 37–39 INDEX loss for utilities is a gain for metals, 43–45 stealth bear market, 43 Stock market crash of 1987 fall of bonds before, fall of dollar with stocks, 8–10 global in scope, 10–12 overview, 6–7 rise of commodities before, stock market peak in August, 7–8 Stovall, Sam, 109, 200–201 Stovall’s circle, 200–201 T Technical Analysis of the Futures Markets, 52, 195 Trading range, 102 Triple top pattern, 22 2000, burst of Nasdaq bubble in See Nasdaq bubble bursts in 2000 2001 recession predicting, 186–187 three markets followed proper rotation for tops, 187 2003 (spring) intermarket picture See Intermarket picture in spring 2003 2002 fall of dollar See Dollar, fall during 2002 boosts commodities W War premium, 134 X XAU (Gold Index), 125–126 ... 12:31 PM Page iii Intermarket Analysis Profiting from Global Market Relationships JOHN MURPHY John Wiley & Sons, Inc ffirs.qxd 10/31/03 12:31 PM Page iv Copyright © 2004 by John Murphy All rights... Page x flast.qxd 10/31/03 12:33 PM Page xi Introduction to Intermarket Analysis n 1990, I completed a book entitled Intermarket Technical Analysis: Trading Strategies for the Global Stock, Bond,... 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)