• The Intermarket Model

    The basic assumption of Intermarket analysis is that all markets are related and what happens in one market is very likely to have an effect on another market. At a macroeconomic level, the four interrelated markets are the Bond, Stock, Commodity and Currency markets, although in our models we do not take into account the currency markets as this market is not part of our investment strategy. Our Intermarket analysis is the analysis of more than one related asset class or financial market on a macroeconomic and microeconomic level. Our analysis looks at several strongly correlated markets or asset classes such as bonds, stocks and commodities with an in-depth analysis in equity sectors and industries.

    To clarify the interaction of the Bond, Stock and Commodity markets within our Intermarket model we can use figure 5.1.

    Figure 5.1: The Intermarket Model

    As explained in the Business Cycle section, the beginning of a new cycle starts from the end of its recession point and here below we describe what we expect from Bonds, Stocks and Commodity prices during the development of the Business Cycle.

    During a recession when business activity contracts, the economy faces a smaller demand for credit and diminishing demand for Commodities. Less inflationary pressure favours a Discount Rate cut by the Monetary Authorities and the Bond market turns up after bottoming. The Stock market and Commodity market are still in a down trend.

    When the recession reaches its lowest level, the Stock market starts to discount the recovery in business activity, and it turns up while increasing Bond prices favour the next recovery (Bonds up, interest rate down). The Commodity market is still in down trend and this favours the bull market in Bonds and Stocks.

    An early expansion takes place in the Business Cycle and Commodity prices turn up as their demand is increasing. The economy is now in an expansion, players in the economy demand more and more credit as their business is developing and the cost of money is still cheap. Now Bonds, Stocks and Commodities are trending up.

    In the next phase, the economy becomes stronger and stronger. While the Stock market still remains a bull market Bonds turn down due to the demand for credit and inflationary pressures caused by soaring commodity prices.

    The economy approaches its maximum activity. The growth of interest rates hurts the expansion of the economy and companies’ earnings. The Stock market discounts the next contraction in the economy, and turns down as Bonds did previously.

    The last stage of the cycle sees a contraction in the economy. Demand for commodities slows due to the contraction in the Business Cycle; Interest rates are still rising and the Stock market discounts further contraction in the economy.

    We have described above how hypothetically the financial markets and Business Cycle are linked to each other and what has been discussed above is a theoretical approach, quite logical but still theoretical.

    The concept of the six stages was introduce by Martin J. Pring [1] in 1990s who, in order to set the stages of the Business Cycle, takes into account macroeconomic indicators. However, in our Intermarket model we take into account only market prices. Actually, all the required information comes from bond, stock and commodity market prices.

    [1] In summer 2005 we developed most of the sector investing analysis published in Martin J. Pring’s book “The Investor’s Guide to Active Asset Allocation: Using Technical Analysis and ETFs to Trade the Markets”, McGraw-Hill 2006.

  • Business Cycle and the Intermarket model

    As quantitative analysts our goal is to prove that this approach is reliable and applicable in investment strategy. Therefore the final step consists of merging the Business Cycle model and the Intermarket model as it is shown in figure 5.2 to see how the two models would look when merged.

    Figure 5.2: Business Cycle and the Intermarket model merged

    Based on the above assumptions we have created a timing indicator which we will call Stages Indicator which will signal the stage we are at. We have also run the same exercise which we ran on the Business Cycle as described in the previous pages and tested the performance of Bonds, Stocks and Commodity at each phase of the Intermarket model.

    From the results below (figure 5.3) it seems that the six stage Intermarket model is very similar to the six phase Business model (figure 5.4). In the simulation of the Intermarket model, the trading strategy always consists of buying and selling the 10-year T-Bond, S&P 500 Index, and CRB Index according to timing signals derived from our Stages Indicator.

    Figure 5.3: Annualised performance in Intermarket model and its phases 1900-2017

    Figure 5.3b: S&P composite and Intermarket phase performance 1900-2017

    Figure 5.4: Annualised performance in Business Cycle and its six phases 1900-2017

    Figure 5.4b: S&P composite and Business Cycle phase performance 1900-2017

  • Intermarket Model Since 1900

    In addition we have run three further studies after the original and we have taken into account different trigger signals, but buying the same assets as above (10-year T-Bond, S&P 500 Index, and CRB Index). The trigger signals came from:

    • T-Bonds, S&P Composite, and CRB Spot Raw Materials (which is slightly different from CRB Index);
    • Commercial Paper Yield (inverted), S&P Composite and CRB Index; and
    • T-Bonds Yield (inverted), S&P Composite and CRB Index.

    Although we changed the timing signal component, the study highlighted no significant differences. On average all of them reached the same conclusion:

    • Stage 1 favourable for Bonds and Stocks (high risk for Stocks) – (deflationary)
    • Stage 2 favourable for Bonds and Stocks – (deflationary)
    • Stage 3 favourable for Stocks and Commodities – (inflationary)
    • Stage 4 favourable for Stocks and Commodities – (inflationary)
    • Stage 5 favourable only for Commodities – (inflationary)
    • Stage 6 favourable for cash – (deflationary)

    Since 1900

    However, it is worth noting that the research is an average over 117 years and that probably in the 80s we would not have the same result as in the 70s, or in the 50s or 40s. We highlight this because long-term cycles play a very important role in the Intermarket model.

    We have also gone back 117 years (1900-2017) and we have calculated how long the markets have spent in each stage (figure 5.5). Figure 5.5 confirms our theoretical Intermarket approach where markets spend more time in stages 3 & 4 which represent the expansion of the economy, and less time is spent in stages 1 & 6, exactly the stages of the contraction (see Business Cycle section).

    Figure 5.5: Percentage of time spent in each stage from 1900-2017


    To verify the results, we decided to take into account also a longer and shorter period of time.

    Comparing data from 1860, 1900 and 1950 (figure 5.6) gives a better picture of how the markets spent the same percentage of time as the model would suggest. Changing the period of time the music does not change, and the Intermarket principles still hold.

    Figure 5.6: Stage comparison between 1860, 1900 and 1950 to date

    First column of each stage from 1860, second column from 1900, third column from 1950.