Most of the literature looking at asset allocation linking multiple markets has a heavy dose of macro and microeconomics. Macro-micro relationships generally require the application of econometric models to understand the structural links between the two intertwined fields of economics. John Murphy eliminates strict statistical methods and preserves economic logic with graph-based reasoning.
John Murphy was a technical analyst for CNBC-TV for seven years and a professional analyst for more than 25 years. His career includes time at Merrill Lynch as Director of Commodity Technical Analysis. John has his own consulting firm, JJM Technical Advisors. He is also president of MurphyMorris, Inc., which was created to produce educational software products and online services for investors.
There are adequate reader reviews on Amazon and Google Book Search, to help you decide whether to get the book. For those just starting out or about to read the book, I’ve broken down the basics into the larger, more essential chapters to help you get through it faster.
The number to the right of the chapter title is the number of pages contained in that chapter. It is not the page number. The percentages represent how much each chapter makes up of the 246 total pages, excluding appendices.
1. A review of the 1980s. 16, 6.50%.
2. 1990 and the First Persian Gulf War. 16, 6.50%.
3. The Stealth Bear Market of 1994. 18.7.32%.
4. The Asian currency crisis of 1997 and deflation. 14, 5.69%.
5. 1999 inter-market trends leading to the top of the market. 16, 6.50%.
6. Review of the Intermarket Principles. 16, 6.50%.
7. The NASDAQ bubble bursts in 2000. 18, 7.32%.
8. Image of Intermarket in the spring of 2003. 16.6.50%.
9. The fall of the dollar during 2002 boosts raw materials. 14, 5.69%.
10. Change from paper to tangible assets. 14, 5.69%.
11. Futures Markets and Asset Allocation. 20, 8.13%.
12. Intermarket Analysis and Economic Cycle. 20, 8.13%.
13. The impact of the economic cycle in the market sectors. 18, 7.32%.
14. Diversification with Real Estate. 18, 7.32%.
15. Think globally. 12, 4.88%.
Focus on chapters 3, 7, and 11-14, which make up about 46% of the book. Especially chapters 11-14 are relevant for practical business purposes. Unlike my previous book reviews, where I have summarized the key points for each focus chapter, I will summarize the key points in chapters 3, 7, and 11-14. This is to recognize the connectivity of relationships between markets across the 4 major asset classes of equities (equities), bonds, currencies, and commodities. The context of the summary should be viewed from the perspective of a retail options trader.
Here are the relationships between key directional markets in brief.
The US dollar (USD)
- The USD appears when bonds rise under normal conditions, but bonds fall during deflationary periods. The USD goes down when bonds fall, but bonds go up during deflationary periods.
- The dollar rises while commodities fall. USD falls as commodities rise.
- The USD appears when stocks rise, but stocks fall during deflationary periods. The USD goes down when stocks fall, but stocks rise during deflationary periods.
The USD remains the most liquid of all major traded currencies and maintains its position as the leading global reserve currency, despite growing sentiment for an alternative basket of currencies to replace it.
jumps
- Bonds appear when the USD falls, but the USD rises during deflationary periods. Bonds go down when the USD rises, but the USD falls during deflationary periods.
- Bonds appear while commodities fall. Bonds go down while commodities go up.
- Bonuses appear as stocks rise. Bonds lead stocks and stocks lag bonds. Bonds fall while stocks fall. Once again, bonds lead stocks and stocks lag behind bonds.
raw Materials
- Commodities rise as USD falls. Commodities go down as the USD goes up.
- Commodities appear while bonds fall. Commodities go down while bonds go up.
- Commodities rise when stocks fall. Commodities go down as stocks rise.
Inventory
- Stocks rise as the USD rises. Stocks down as USD falls.
- Stocks go up as bonds go up. Stocks fall while bonds fall. Once again, bonds lead stocks and stocks lag behind bonds.
- Stocks rise while commodities fall. Stocks go down while commodities go up.
For stocks specifically, when trading options on the S&P 500 sector indices, consider correlation versus non-correlation with other stock and non-stock traded products. I am stating briefly, the most commonly known relationships that are repeatedly elaborated in the book:
- Changes in energy (XLE), especially oil (OIH, OSX), affect semiconductors (SMH, SOX).
- Utilities (XLU, UTH, UTY) are negatively correlated with Semiconductors (SMH, SOX).
- With broad-based equity indices, the highest correlation is between the Dow Jones and the S&P 500.
- Canada benefits from oil rallies by being the ninth largest producer of crude oil in the world. While Japan, a major net importer of oil, suffers. The tickers for this interaction would be FXC/XDC (Canadian dollar), FXY/XDN (Japanese yen) and OIH/OSX (oil).
- Gold (XAU, GLD) behaves like the Australian dollar (FXA, XDA). Australia is the third largest gold producer in the world.
- The three major currencies that have the closest correlations to commodities are the Australian dollar, the Canadian dollar, and the New Zealand dollar.
- Gold/Silver (XAU, GLD) has very little correlation with other indices.
A deeper understanding of these interactions can help you build effective pair trading methods.
In conclusion, from a retail options trader’s point of view, always remember that what you are trading is volatility. To trade volatilities across multiple asset classes, use an optional index that represents that particular asset class. Remember, implied volatility can add to or reduce your portfolio, as not all asset classes or sectors or individual companies or countries ALL go up or down in value at the same time; and/or, ALL at the same rate.
This is not a comment on the book but a personal observation. It does not address the use of relative strength as a mechanism to enter or exit an asset class, as one asset class weakens or strengthens against another asset class. I have written about relative strength in another article, titled “Stock Options Trading: Fundamental Flaw in Fundamental Analysis and Stock Picking.” Please read it as a supplement to this article.