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Smart investor guide: 3 predictable intermarket relationships

Smart investors recognize that the stock market doesn’t exist in a vacuum.
Key Takeaways
  • The activity of one market can have surprising effects on other markets, even ones that might seem completely unrelated.
  • Some of these so-called intermarket relationships are quite established and, to a degree, predictable.
  • Here are some of the most common intermarket relationships, as well as some of the ways that investors take advantage of them. 

When the stock market declines, it may feel like the end of the world — but it’s not always bad news for everyone. It might sound counterintuitive, but when one asset decreases in price, it can raise the value of another asset.

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Why? Each market responds to changing conditions in unique ways. For example, as the world has been grappling with supply-chain disruptions, high inflation, and rising interest rates over the past couple years, the U.S. dollar and the stock market have been moving in opposite directions.

In other words, when investors are optimistic (or “bullish”) on the U.S. dollar, which is seen as a “safe haven” asset around the world, they tend to be pessimistic (or “bearish”) on stocks. Let’s look at these types of relationships in further detail.

Understanding markets and cycles

When people talk about “financial crashes” or “bull markets,” they’re probably referring to the ups and downs of the stock market. To be more specific, they’re likely talking about the world’s biggest stock exchange: the New York Stock Exchange. (To be sure, there are dozens of stock exchanges around the world, from the NASDAQ to the Hong Kong Stock Exchange.)

But there’s more to investing and financial markets than stocks. Investors can also trade:

  • Commodities: such as precious metals, oil, gas, and sugar.
  • Bonds: debt instruments that give you a small return by you lending money to a government, company, or another organization.
  • Currencies: such as the U.S. dollar, Japanese yen, or Euro.
  • Real estate: either properties or funds related to properties.
  • Cryptocurrencies: Bitcoin, Ethereum, or one of the smaller “altcoins.”

Investors may purchase any of these assets in the hopes they will increase in value. But it’s important to realize that assets from any one of these classes won’t always move in the same direction as assets in another.

Factors that affect prices

From geopolitical events to market speculation to a scandal involving a company’s CEO, there are many factors that can move the markets. That’s another way of saying there are many things that can psychologically influence investors to buy or sell, which is essentially the only way stock prices move up or down.

Markets can also go through their own boom and bust cycles, meaning a period of increasing prices (boom) followed by a phase of decreasing prices (bust). This happens for reasons too complex to get into here, but it essentially centers on consumer demand and investor interest increasing and then waning.

However, all the markets outlined above won’t necessarily move in the same direction at the same time — consumers and investors will react to them differently, and external shocks will affect them differently.

Just think of two companies in different markets. A government policy that gives subsidies to clean energy would positively impact the value of a clean energy firm, but would damage a fossil fuel company. Their stock prices would reflect this.

Markets experience the same phenomenon, and some of these so-called intermarket relationships are quite well established and, to a degree, predictable. 

Established market correlations

The idea that one market can impact another is intuitive enough. To give a simple example, Aliaksei Hapeyeu, a stock market analyst who previously worked at Dara Trade, explains how oil prices can affect transportation companies. 

“In general, high oil prices are bad for the transport industry on the stock market,” Hapeyeu says. “The higher the price of oil, the more expenses the company has. That is why a negative correlation exists between crude oil and airlines and cruise ships companies.”

Basically: The performance of one market affects the profitability of or demand for another market. The above example demonstrates a negative correlation, but positive correlations also exist, meaning that when X market performs well, Y market also tends to do well, too.

Bonds and stocks

Let’s start with bonds. They tend to be a less risky but also less profitable investment than stocks. Many investors regularly compare the returns between stocks and bonds. As a result, when the price of bonds changes, it affects the demand for stocks (and vice versa).

Is the correlation positive or negative? That depends on what’s happening in the broader economy. The general theory is that bond prices rise when stocks fall since poor performance of the stock market makes bonds more appealing (due to their low risk). 

But — and this can get confusing — this relationship hasn’t been playing out recently due to the role of interest rates. After all, when interest rates are high, it’s more expensive for businesses to borrow money (something that helps them grow).

On the side of the stock market, stock prices fall when interest rates are high since businesses struggle. Meanwhile, the bond market also wanes, because high interest rates mean investors can also obtain yields from financial products like savings accounts. 

In conclusion: The bond and stock markets tend to be negatively correlated, but that changes when interest rates are high.

Currencies and commodities

The currency and commodity markets are also very interrelated. If a country relies on exporting a commodity (like oil), a price increase of that commodity results in the exchange rate rising. For example, Canada exports a lot of West Texas Intermediate (WTI) crude oil, and there’s often a strong correlation between the Canadian dollar and the price of WTI. 

Commodities and bonds

Finally, there are relationships between commodities and bonds. Higher commodity prices cause inflation, since the world relies on oil for production and just about every other major industry. Then, higher inflation makes governments raise interest rates to control inflation and reduce spending — and this makes bond prices increase (for the reasons outlined earlier).

The result is a positive correlation between commodity and bond prices.

Assets that may appreciate when stocks plummet

Clearly, there’s more to investing than just the stock market, and all markets are related to each other in different and complex ways. But which assets tend to appreciate when stocks plummet, and why?

“Safe haven assets” are defined as assets that tend to hold value over time, regardless of the boom and bust cycles of other markets. Gold has always been the typical example of this. However, demand for gold hasn’t always increased or remained stable — recently, gold prices have dropped despite the stock market turbulence.

But as Hapeyeu explains:

“There are a lot of options for those who are eager to earn during the market crash. A good choice is precious metal funds. Some of them track the prices of precious metals while others invest in the mining companies or refining industries.”

The real estate market may also increase when stock prices plummet. Since properties are inherently valuable — people will always need somewhere to live — demand for them may sometimes remain high even when stocks crash. This happened during the brief COVID-19 stock market crash.

Hapeyeu adds that a “REIT (Real Estate Investment Trust) is a good investment during the turmoil as well. In general, REIT is little correlated to the stock market, making REIT a good hedge against crashes. In addition, they generate higher dividends than many other stocks.”

What it means for you

Ultimately, markets are complex. Economists like to make theories about how one market will react to another, but the reality is that there’s always a wide range of factors at play.

If you’re interested in protecting your wealth for your retirement years, the best thing you can do is to be aware of the general relationship between major asset classes, and to build a diverse portfolio that contains a mixture of various asset types. This way, you won’t be reliant on one market performing well.

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