The 2 Strongest Intermarket Trends

06/13/2012 12:30 pm EST

Focus: TRADING

John Murphy

Head Market Analyst, Stockcharts.com

Changes in the correlation between stocks and bonds and stocks and commodities make for compelling new trading opportunities in an era John Murphy calls the "new normal."

The new normal and sector interplay within that new normalcy. We’re with John Murphy, who is going to talk to us about his research and his views on how this is playing out.

Well, I’m a technical analyst, basically, but intermarket analysis is something I started writing about 20 years ago—bonds, stocks, commodities, currencies, global markets—how they interact with each other. The "new normal" simply explains that over the last decade or so, some of these traditional relationships have changed a bit.

We all know that when the dollar goes down, commodities go up, but the one that really has changed is the relationship between bonds and stocks. Since 2000, bond prices and stock prices move in the opposite direction. Prior to 2000, that wasn’t the case.

So, on any given day you’ll notice if stocks are up, Treasuries are mainly down. I think that’s a result of deflationary pressures over the last decade.

The other one is that a very close relationship has developed between commodities and stocks. That started around 2000, and since 2008, that’s become even more so. Again, I think that’s a result of deflation.

If you go back to the 1930s—the last time we had even a whiff of deflation—that was basically the model. Stocks and commodities moved in the same direction; bonds moved in the other direction.

That’s what I mean by “new normal”…just those two relationships have changed.

Well, how would a trader play that? Are there any specific ways and strategies?

Yes, for example, I mainly trade ETFs. So, you can look at the bond market for clues. Usually, if one of the bond ETFs like the iShares Barclays 20+ Year Treasury Bond Fund (TLT) or iShares Barclays 7-10 Year Treasury Bond Fund (IEF) are rising, that’s normally a bearish signal for stocks.

Or you could look one to the other. Bond yields normally move in the same direction of the stock market, and over the last two or three years, every time bond yields have turned down, stocks have followed shortly thereafter. So bond yields often act as a leading indicator for stocks.

Stocks have been rallying recently while commodities have been lagging behind. Now, that’s not unusual. Normally, stocks will turn up before commodities, but commodities will always follow along.

So, the fact that stocks have been rallying and commodities have been lagging tells me that commodities are going to start to play catch up.

The point is you can’t just trade one market by itself. You have to know what’s going on with the other markets.

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