Level 3 Intermarket Analysis

1. Level 3Intermarket Analysis

2. Summary • Introduction • Fixed Income vs Stocks • Fixed Income vs Commodities • Commodities vs US Dollar • Sectors & Groups • Deflation Scenario • Homework

3. Introduction • Benefits of Futures Markets • Inflation often “seen first” in futures • Dollar trends tell a lot about health of the economy • This has impact on corporate earnings & valuations • Helpful in judging “where we are” in business cycle (sector rotation)

4. Business Cycle Road Map

5. Bonds vs Stocks • Directly Related • Fixed Income is leading indicator of the stock market • Fixed Income prices move opposite to yields • FI prices rise, Yields fall (loose policy) • Normally good for the equity market • FI prices fall, Yields rise (tight policy) • Normally bad for the equity market (Beware deflation)

6. Fixed Income vs Commodities • Inversely Related • Inflation is the Key • Commodity prices are leading indicator of inflation • FI prices rises, Yields fall (loose policy) • Commodity prices rise due to cheap money • FI prices fall, Yields rise (tight policy) • Interest rates rise to combat high commodity prices (think July 2008 ECB rate hike )

7. Commodities vs US Dollar • Inversely Related • Inflation (again) is the Key • Rising US Dollar is considered to be non-inflationary • FI price rise, Yields fall (loose policy) • Dollar is less attractive investment • Gold most common alternative to weak Dollar • FI price fall, Yields rise (tight policy) • Dollar is more attractive investment

8. Commodities vs US Dollar

9. Sectors & Groups • Bonds vs Commodities • Utility stocks follow Bonds • Mining shares follow Gold • Gold mining shares are leading indicators of Gold prices • Dollar vs Large Caps • Strong USD hurts multinationals • Strong USD can benefit small caps

10. Sector Rotation

11. Sector Rotation cont’d

12. Group Rotation - Pring

13. Relative Strength Analysis • Critical Use • Goal is to assess strongest market • Very useful in assessing Sectors • Divide one market by another • Result is a ratio line • Rising favors dividend (top market) • Falling favors divisor (bottom market)

14. Relative Strength Analysis

15. Relative Strength Analysis

16. Deflation Scenario • 1970’s • Inflation favored commodities • 1980’s, 1990’s • Disinflation favored equities • Asian Currency Crisis of 1997 • Damaged commodity prices • Raised the question: • Are falling prices really good for market? • (corporate loss of pricing power)

17. Deflation (cont’d) • Fixed Income prices vs Stocks • Relationship began to decouple • Investors moved to Fixed Income • Investors moved to rate sensitive stock groups, like Utilities • Fixed Income vs Commodities • Inverse relationship • Commodities fall, while FI prices rise

18. Deflation (cont’d) • The Difference • Stock market can react negatively in Deflation scenario • Disinflation is bad for Commodities • Disinflation is good for FI prices • Disinflation is good for Stocks • BOTTOM LINE • Deflation decouples FI vs Stocks • Bonds rise, but market falls!

19. The S&P500 & 10yr yields

20. The S&P500 & S&P GSCI

21. EUR/JPY and the S&P500

22. Intermarket warning

23. Correlation as a secondary indicator

24. Homework • Analyze the following Charts • Indicate where we are in the business cycle and why • Suggest which sectors should do best • And which sectors should do poorest

25. US Ten Year Notes

26. S&P500

27. WTI Crude Oil

28. US Dollar Index