Every market you can invest in is connected. Every single one.
Markets are connected because ultimately, it’s the same people who are doing the buying as the selling. That fact is particularly noticeable now, following Ben Bernanke’s announcement of QE3: After the announcement, stocks rallied hard and Treasury notes dropped equally hard.
But that relationship wasn’t due to magic. Put simply, it happened because folks pulled a bunch of cash out of Treasuries (dropping their price) and dumped it in stocks (hiking their price). The flow of funds from one asset class to another is called intermarket analysis — and it can tell you a lot about what’s going on in the economy and in the specific markets we trade.
Right now, intermarket analysis is telling us that stocks are still a good bet. Today, I’m going to show you why. I’ll dissect three basic asset classes: stocks, bonds and commodities. Believe it or not, you can glean a lot of insight from just three charts.
Let’s start with stocks…
This probably isn’t the first time you’ve seen the chart above — it’s a daily candlestick chart of the S&P 500, our proxy for the stock market.
A quick look at the chart should tell you a few important things… For starters, it’s clear that the orderly rally that stock investors have been enjoying isn’t showing any signs of slowing down just yet. Stocks have been bouncing higher in a trading channel since the start of June, and they’re still trading within that channel. Stocks broke through resistance at 1,420 to a new high in early September, giving investors an important psychological boost.
After all, selling pressure becomes a whole lot less desperate when everyone who’s bought stocks in the last year is sitting on gains. And momentum, measured by 14-day RSI, remains in an uptrend still. Since momentum is a leading indicator of price, that’s an indication that last week’s sideways correction was just that. A similar story is shaping up in commodities — namely gold…
Gold isn’t your typical commodity — especially with market conditions making the metal trade more like a currency than anything else right now. But I think it’s the commodity market that’s most worth investigating this month…
Taking a look at the chart, gold is roughly approximating stocks right now. Both markets bottomed at nearly the same time at the start of the summer, and both have been rallying hard since. While gold’s rally hasn’t been as orderly as the rise in stock prices has been, the uptrend in gold prices has accelerated faster than stocks have since mid-August.
At this point, investors should expect the yellow metal to keep moving up — and to keep trading in tandem with stocks.
But there’s a different story in bonds…
The chart above shows the price of a 10-year U.S. Treasury note, a pretty good proxy for “interest rates” in general.
Treasuries peaked at almost the same time stocks bottomed. While bond prices (like these Treasuries) historically lead stocks, that hasn’t been the case since the market crash of 2008. Since then, Treasuries have been the “I hate risk” trade, offering investors a safety net from stocks. This chart above shows that’s still the case right now.
A quick look at the Treasury chart shows that it’s declining in an orderly channel that’s almost a mirror image of the one in stocks. The obvious conclusion to that is that a lot of the cash in the Treasury market (and yes, there is A LOT of cash piled in the Treasury market right now) is moving directly into stocks, save for a bit that’s getting funneled off to gold.
And since there’s so much money in Treasuries right now, there’s a lot of money sitting out of stocks that could be ready to get back in as horrifically low interest rates, inflation’s creep higher, and dropping Treasury prices squeeze the very folks who were buying Treasuries to escape risk.
As long as these intermarket relationships hold up, stocks look like a good bet. And now that I’ve shown you where to look, you should make it a point to explore intermarket forces at least once a month to make sure your trading dollars are in the right place.
Sincerely,
Jonas Elmerraji, CMT
Why Stocks Are Still a Good Bet was originally featured in the Tomorrow In Review.
