as a tool that can be used to confirm signals given by classical technical
analysis as well as to predict future market direction. John J. Murphy,
CNBC’s technical analyst and the author of Intermarket Technical Analysis
(John Wiley & Sons, 1991), is considered the father of this form of
analysis. In his book, Murphy analyzes the period around the stock market
crash of October 19, 1987, and shows how intermarket analysis
warned of impending disaster, months before the crash. Let’s examine
some of the intermarket forces that led to the 1987 stock market crash.
Figure 1.1 shows how T-Bonds began to collapse in April 1987, while
stocks rallied until late August 1987. The collapse in the T-Bond market
was a warning that the S&P500 was an accident waiting to happen; normally,
the S&P500 and T-Bond prices are positively correlated. Many
institutions use the yield on the 30-year Treasury and the earnings per
share on the S&P500 to estimate a fair trading value for the S&P500.
This value is used for their asset allocation models.
T-Bonds and the S&P500 bottomed together on October 19, 1987, as
shown in Figure 1.2. After that, both T-Bonds and the S&P500 moved in
a trading range for several months. Notice that T-Bonds rallied on the
day of the crash. This was because T-Bonds were used as a flight to
safety.
T-Bond yields are very strongly correlated to inflation; historically,
they are about 3 percent, on average, over the Consumer Price Index
(CPI). Movements in the Commodity Research Bureau (CRB) listings
are normally reflected in the CPI within a few months. In 1987, the CRB
had a bullish breakout, which was linked to the collapse in the T-Bond
market. This is shown in Figure 1.3. The CRB, a basket of 21 commodities,
is normally negatively correlated to T-Bonds. There are two different
CRB indexes: (1) the spot index, composed of cash prices, and (2) the
CRB futures index, composed of futures prices. One of the main differences
between the CRB spot and futures index is that the spot index is
more influenced by raw industrial materials.
Eurodollars, a measure of short-term interest rates, are positively correlated
to T-Bonds and usually will lead T-Bonds at turning points. Figure
1.4 shows how a breakdown in Eurodollars preceded a breakdown in
T-Bonds early in 1987.
Read More : WHAT IS INTERMARKET ANALYSIS?
