Level 1 CFA® Exam:
Intermarket analysis is about studying the mutual relationships between markets. Technical analysis is most commonly identified as the source of intermarket analysis, pioneered by John Murphy.
The intermarket analysis allows us to select the most attractive markets and leave those projected to decline. Intermarket analysis is mostly used to study the relationships between the currency, commodity, bond, and stock markets.
The fundamental assumption in intermarket analysis is that markets influence one another. None of them is independent and isolated from the others.
What can be the connection between, say, the bond market and the stock market? Low interest rates result in high prices and lower profits on bonds. At the same time, low interest rates mean the cost of money is low, which companies take advantage of to borrow money and go through with investment projects.
Improving the results and prospects of companies make investors move their capital to the stock markets, which offer better rates of return than debt securities.
When interest rates and security prices go up (and they grow faster than companies' profits and dividends earned by investors), the stock market becomes less attractive. Another effect of high interest rates is that the prices of debt securities go down to a low level. This is when investors start moving away from the stock markets and focusing on debt securities.
Next, interest rates start to go down again and the cycle closes. Obviously, this sample analysis could, and should, include other markets, such as currency and commodity markets. However, we're not going to deal with that in this lesson.