QuantitativeExhaustion

Stage 4 to Stage 5 of Intermarket Analysis, Financials vs Bonds

NYSE:C   CITIGROUP INC
690 7 21
Citibank C is the first to report bank earnings Monday April 15 before the market open. If you think bonds might have a chance to break higher and or you believe Citibank might scale down it's 2013 guidance, Friday would be a good time to short the market. If you think bonds are ready to break lower or Citigroup             is going to beat analyst expectations, you should stay the course with your long positions; although watch big technology heavy hitters Apple             AAPL             and Google             GOOG             , might be a concern the following week.

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Today's big banks are different than banks of 40 years ago. Big banks such as Citibank are all over the world. Citibank will do very well when China, India, and Brazil's economies start to pick up to near double digit growth, much like before the financial crisis. Many are also worried over the global housing bubble in these developed countries. China's government has attempted several times to slow the housing bubble, but people are still exuberant over buying a house and living the "American dream". The dream might be a nightmare for those who didn't notice what took place in the United States from 2000 to 2008. Americans know the story very well. China will most likely burst next year, but Citi and other mega banks stand to gain profits before the topple.

There has been a strong inverse relationship with banks and bonds over the years. Banks thrive in environments when bonds go down and economies heat up. Unfortunately, however this is often in the latter stages of a business cycle when inflation really starts to pick as well. Right now the US economy is in a slow to steady rise while developed countries have been caught up in a slow down for a year now. The developed and developing world however might be nearing a period of rapid growth.


John Murphy

Intermarket analysis is a branch of technical analysis that examines the correlations between four major asset classes: stocks , bonds, commodities and currencies . In his classic book on Intermarket Analysis, John Murphy notes that chartists can use these relationships to identify the stage of the business cycle and improve their forecasting abilities. There are clear relationships between stocks and bonds, bonds and commodities , and commodities and the Dollar. Knowing these relationships can help chartists determine the stage of the investing cycle, select the best sectors and avoid the worst performing sectors.
Inflationary Relationships
Business Cycle

Stage 1 shows the economy contracting and bonds turning up as interest rates decline. Economic weakness favors loose monetary policy and the lowering of interest rates, which is bullish for bonds.

Stage 2 marks a bottom in the economy and the stock market. Even though economic conditions have stopped deteriorating, the economy is still not at an expansion stage or actually growing. However, stocks anticipate an expansion phase by bottoming before the contraction period ends.

Stage 3 shows a vast improvement in economic conditions as the business cycle prepares to move into an expansion phase. Stocks have been rising and commodities now anticipate an expansion phase by turning up.

Stage 4 marks a period of full expansion. Both stocks and commodities are rising, but bonds turn lower because the expansion increases inflationary pressures. Interest rates start moving higher to combat inflationary pressures.

Stage 5 marks a peak in economic growth and the stock market. Even though the expansion continues, the economy grows at a slower pace because rising interest rates and rising commodity prices take their toll. Stocks anticipate a contraction phase by peaking before the expansion actually ends. Commodities remain strong and peak after stocks.

Stage 6 marks a deterioration in the economy as the business cycle prepares to move from an expansion phase to a contraction phase. Stocks have already been moving lower and commodities now turn lower in anticipation of decreased demand from the deteriorating economy.

Keep in mind that this is the ideal business cycle in an inflationary environment. Stocks and bonds advance together in stages 2 and 3. Similarly, both decline in stages 5 and 6. This would not be the case in a deflationary environment, when bonds and stocks would move in opposite directions.
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Conclusions

Intermarket Analysis is a valuable tool for long-term or medium-term analysis. While these intermarket relationships generally work over longer periods of time, they are subject to draw-downs or periods when the relationships do not work. Big events such as the Euro crisis or the US Financial crisis can throw certain relationships out of whack for a few months. Furthermore, the tools shown in this article should be used in conjunction with other technical analysis techniques. The XLY/XLP ratio chart and the Industrial Metals/Bond Ratio chart could be part of a basket of broad market indicators designed to assess the overall strength or weakness of the stock market. One indicator or one relationship should not be used on its own to make a sweeping assessment of market conditions.

http://stockcharts.com/school/doku.php?id=chart_school:overview:intermarket_analysis
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snapshot


Inverse Relationship between Japans largest bank Mitsubishi UFJ Financial Group MTU and Japanese Bonds
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Price still commanding in Lower Price channel quadrant
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RyanT
2 years ago
Very nice!
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