Intermarket Analysis

Inter-market analysis refers to a method of determining the strength or weakness of an asset class or financial market relative to other related asset classes or financial markets. These asset classes may include stocks, bonds, commodities, or even loan facilities. Inter-market analysis  focuses on comparing asset classes instead of individual assets. The overall goal of the inter-market analysis is to identify top performers or the markets that are outperforming others. Such comparisons can be very helpful to investors as they seek to maximize their wealth.

Breaking down Intermarket Analysis 

Inter-market analysis is actually a small area within the larger field of technical analysis. It involves a detailed study of the major asset classes to identify market trends, including possible inflections. We can expand this type of analysis to include industry subsectors. For example, the method can be used to compare the 9 sectors that together make up the S&P 500.

It’s common to find market analysts comparing the performance of stock markets across international borders. Stock market analysts give due attention to the world’s most developed economies because such economies have a trickle-down effect on other smaller counterparts . As such, the trends in these markets often have an instant sponteneous effect on  smaller markets.  Examples of the world’s most developed markets may include the London, New York, and Shanghai stock exchanges.

Inflection points in one market may  may inform the anticipation of   a change in trend in a different but closely related market. One of the tools used to study inter-market relationships comes in the form of relative strength analysis.

Relative strength analysis directly compares the prices of two securities. The method involves dividing the price of one security by the price of another security and then presenting the results in the form of a chart.

Why is Intermarket Analysis so Important?

Trade veterans will always tell you how important it is to have a diversified portfolio, i.e., onethat’s not limited to just one asset class or country. Diversification reduces the overall risk borne by  an investor. A diversified portfolio is a direct beneficiary of the inter-market analysis. By following multiple markets, investors can detect significant market changes earlier than investors who focus  just on one market. The investor with an inter-market strategy can then move holdings from one sector or country to another so as to dodge avoidable economic downturns and maximize their returns.

Question 

Which of the following is most likely the goal of intermarket analysis?

1. It is a diversification tool.
2. It creates inflection points.
3. It helps an investor detect significant market changes.

Solution

The correct answer is C.

Intermarket analysis refers to a method of determining the strength or weakness of an asset class relative to other related asset classes. It helps an investor detect significant market changes earlier.

A is incorrect. It is particularly important to a diversified portfolio. However, it is not a diversification tool in itself.

B is incorrect. By using intermarket analysis, investors can identify inflection points but intermarket analysis does not create inflections points in itself.