Futures For YouQ&A
Futures For YouInside The Futures World
Want to find out how the futures markets really work? Carley Garner is the senior strategist for DeCarley Trading, a division of Zaner Group, where she also works as a broker. She authors widely distributed e-newsletters; for your free subscription, visit www.DeCarleyTrading.com. Her books, Currency Trading in the Forex and Futures Markets, A Trader’s First Book on Commodities, and Commodity Options, were published by FT Press. To submit a question, post your question at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.
INTERMARKET RELATIONSHIPS FOR FUTURES TRADERS
An intermarket relationship is simply the manner in which particular markets behave in relation to each other; more specifically, it is the correlation between two otherwise unrelated markets. Among the most monitored relationships are those between stocks and bonds, and the US dollar and commodity prices.
Most people assume that stocks and bonds will always be negatively correlated (that is, moving in the opposite direction). But this is a simplistic view that suggests investors have only two choices, stocks and bonds; money moved out of one typically coincides with money moved into the other. There are, however, times when both assets can move higher or lower together. For example, in the early stages of the Federal Reserve’s quantitative easing campaign, the never-ending printing of US dollars and the subsequent need for liquidity to find a home caused nearly all asset prices to move higher in lockstep. During this time, the equity market and Treasury securities were both able to climb to multiyear highs. And again more recently, statistics on the past 180 trading days, as of early June, suggest that the S&P 500 futures contract and the 30-year bond futures contract were negatively correlated a mere 40% of the time. This leaves plenty of time (60%) for the markets to be trading outside of what is the conventional expectation.
An interesting intermarket relationship that is surprisingly reliable but that has managed to go under the radar is the negative correlation between the S&P 500 and the Japanese yen. According to stats spanning the previous 180 trading sessions (as of early June), these two markets traded in opposite directions approximately 91% of the time! Based on this information, anyone who was looking for a crack in what was then the magnificent stock rally may have looked to any strength in the yen versus the dollar (a higher yen futures contract, or a lower USD/YEN in forex) as a hint toward a reversal.
Live cattle futures are among the most responsive contracts to changes in the dollar.Shifting gears to commodities, most traders are aware that a higher dollar has a tendency to put pressure on dollar-denominated commodities, such as the grains, energies, metals, and even meats. This makes sense because a higher dollar value makes exports more expensive for foreign buyers; as a result, commodity demand falls and, consequently, so does price. Similarly, a weaker dollar gives a boost to commodity prices because it encourages demand for the products.
It is sometimes surprising to see just how strong the relationship is, and even more so, which markets are more sensitive to changes in currency values. For instance, few would guess that live cattle futures are among the most responsive contracts to changes in the dollar. Specifically, live cattle prices and the greenback are negatively correlated nearly 90% of the time. Meanwhile, corn, wheat, and soybeans are negatively correlated to the dollar about 70% of the time. You might be astounded to learn that the yen futures contract and wheat move in the same direction approximately 94% of the time, as measured by the past 180 trading sessions. It is rare to see such a strong relationship between what most consider independent markets.
I am a big fan of watching intermarket relationships because in most instances, one market will make a move before the other. In such a scenario, the discrepancy in the normal relationship might offer a hint at what is potentially in store for future price moves. With that said, this type of analysis falls into line with any other in that it is a tool to guide decision-making but shouldn’t be followed blindly or used without corroboration from other indicators and techniques.
The practice of using intermarket relationships to guide speculation has been difficult in recent months. Many of the correlations traders had come to rely on have dissipated or even reversed; accordingly, any trader making the mistake of putting too much faith in this type of analysis might have suffered the consequences. Just as the markets are dynamic and ever-changing, so are the relationships between asset classes. The key to benefiting from intermarket relationship analysis is being nimble and adapting to change.