The Market is big and confusing.With Multiple stocks and sectors it can be overwhelming for an average retail Investor But by understanding how the different financial markets interact with each other, the bigger picture can become much clearer. Observing the relationship between stock market as whole comparing with bonds, commodities and currencies gives an absolute advantage for a Market player which will lead to a much smarter trade opportunities compared to single market/Asset analysis .One of the main reason why an average Indian investor loses is because a lack of understanding on what’s behind the market movements. Majority of the time as I noticed, Indian retail player is engaged with single asset analysis or failing to grasp what is the main mover behind the major trends, what’s worse in some cases are blindly sticking to their bias even when the market turns around it back[wp_ad_camp_5]
What is Inter-market analysis ?
There is a general order in which markets are linked together due to various factors like global economic policies,Interest rate cycles etc. By watching the country’s financial market as a whole (means currency,commodity,stock market and bond prices), we are better able to assess the direction in which a market is shifting. All four markets work together. Sometimes move with each other, and sometimes against.The reason to look the market in this way is to understand or grasp which is the major theme causing the market prices fluctuate with or against each other. By absorbing the main theme,we can make good trading decisions and capture better profits
Application- simple and easy
Oh! I got it – reading my former two paragraphs some might have already confused or thinking this is tough and complex rather some of you might be saying “this guy is creating a complicated way to analyse the market” No worries- Applying Inter-market analysis is very simple and easy.Once you start looking the markets this way, You really gonna love it and understand major reasons behind the price movements. The only requirement you should have is some basic knowledge of how to look at the price chart
Let’s begin by looking at how commodities, bonds, stocks and currencies interact. As commodity prices rise, the cost of goods is pushed up. This increasing price action is inflationary and interest rates also rise to reflect the inflation. Since the relationship between interest rates and bond prices is inverse, bond prices fall as interest rates rise.Bond prices and stocks are generally correlated. When bond prices begin to fall, stocks will eventually follow suit and head down as well. As borrowing becomes more expensive and the cost of doing business rises due to inflation, it is reasonable to assume that companies (stocks) will not do as well Once again, we will see a lag between bond prices falling and the resulting stock market decline
Take a Look at US stock Dividend yields and Bond Yields How the correlation is unfolding(1954-2008)
The currency markets have an impact on all markets, but the main one to focus on is commodity prices Commodity prices affect bonds and, subsequently, stocks. The USD and commodity prices generally trend in opposite directions. As the dollar declines relative to other currencies, the reaction can be seen in commodity prices
Indian stock market have different tendency to the fluctuation in USD/INR which is visible in the following chart (Till 2008)
Inter-market analysis is not a method that will give you specific buy or sell signals. However, it does provide an excellent confirmation tool for trends, and will warn of potential profit opportunities
Inter-market analysis is a valuable tool when investors understand how to use it. However, we must be aware of the type of economic environment we are in over the long term, and adjust the relationships we will see accordingly. Inter-market analysis should be used as a tool to judge when a certain market is likely to reverse, or whether a trend is likely to continue Just go ahead pop the different market charts together and see how the relationship holds and let me know in comments what do you guys think about the recent market situations from an Inter-market view
4 Replies to “Capture Profits by Fixing the Puzzle of Inter-market relationships”
What is the correlation between us bond yield and Indian bond yield. I understand that there is huge carry trade(some kind of arbitrage by FII in this front. I hear that when fed rate will increase lot debt money out flow will occur which will cause currency fluctuation. I understand RBI can contain it because of its reserves. People were talking rupee back to 70 level during those times. Can you explain.
Your Answer is in the question-The phenomena that was underplay due QE unwinding by FED is liquidation of “Global Interest rate arbitrage” which made EM currencies to devalue rapidly and increased inflation in Developing markets.Many Emerging market currencies got hit during 2nd QUARTER of 2013 due to rapid capital outflows.
What is this arbitrage our bond yields are are 8.44 and us bond yields I think 2..37. I heard chris wood talk about this in greed and fear. Wanted to know what are exact interest differentials which will cause the outflow. What data points will trigger FII to act.
There are big Financial institutions like Investment banks,Insurance companies,Hedge-funds etc who are eagerly looking to gain yields by borrowing on lower interest rate and investing on higher interest rate globally and hedge their foreign currency risks through forwards and currency swaps which in case allowing them to gain rapid advantage of global interest rate differentials For example US yields are around 2.37% and India’s yield is around 8.40%.So there is an opportunity for an Investor to take advantage of the higher interest rate in India by borrowing at lower rate in US.When they feel the Interest rate in US is going to rise they dump Indian bonds in anticipation of upcoming rate rise and profit squeeze in turn causes rise in Indian yields and depreciation of INR which happened during 2nd quarter of 2013.So in this case we need to pay attention to US Bonds,Indian Bonds and USD/INR helps us look clearly into the trend. This is just a part of knowledge we teach to our investors in professional course and there is also a lot of other factors we need to watch for.