may not rise or fall at exactlythe same speed or time, all are influenced by the global trend. A stock investor in theUnited States wouldn't consider buying an individual stock without first determiningthe direction of the U.S. stock market as a whole. In the same way, an analysis ofthe U.S. stock market wouldn't be complete without determining whether the globalequity trend is in a bullish or bearish mode. (It's worth noting here that global trendsare also present for interest rates and inflation.): Figure 8.1 shows the generally bullish trend from 1985 through the end of 1989,with the downward interruption in all three markets in the fall of 1987. Figure 8.2
FIGURE 8.1A COMPARISON OF THE JAPANESE, AMERICAN, AND BRITISH STOCK MARKETS FROM 1985THROUGH 1989.The Three Major Global Markets: U.S., japan, and Britain
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FIGURE 8.2THE WORLD'S THREE LARGEST STOCK MARKETS RESUMED UPTRENDS TOGETHER IN EARLY1987 AND COLLAPSED TOGETHER IN THE FALL OF THE SAME YEAR.Global Equity Markets Resumed Uptrend as 1987 Beganand Crashed Together in the Fall of the Same Year
focuses on the events of 1986 and 1987. As 1987 began, all three markets were completing a period of consolidation and resuming their major bull trends. In the secondhalf of 1987, all three markets underwent serious downside corrections. Figure 8.3focuses on the 1987 top in the global markets and holds two important messages:• All three equity markets collapsed in 1987.• Britain peaked first, while Japan peaked last.THE GLOBAL COLLAPSE OF 1987
The first important message is that all world markets experienced severe selloffs inthe second half of 1987. When events in the United States are examined on a globalperspective, one can see that the U.S. experience was only one part of a much biggerpicture. The preoccupation with such things as program trading as the primary causeof the U.S. selloff becomes harder to justify as an adequate explanation. If programtrading caused the U.S. selloff, how do we explain the collapse in the other world
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FIGURE 8.3AT THE 1987 PEAK, THE BRITISH STOCK MARKET PEAKED IN JULY, THE AMERICAN MARKETIN AUGUST, AND THE JAPANESE STOCK MARKET IN OCTOBER. BRITAIN HAS HAD A LONGHISTORY OF LEADING THE U.S. MARKET AT PEAKS.The British Stock Market Peaked a Month Before the U.S. in 1987while Japan Didn't Peak Until October
markets that didn't have program trading at the time? Clearly, there were and aremuch larger economic forces at work on the world stage. In Chapter 14, I'll havemore to say about program trading.The second message is the chronological sequence of the three tops. The Britishstock market peaked in July of 1987, a full month prior to the U.S. peak whichoccurred in August. The British market has a tendency to lead the U.S. market atpeaks. (In the fall of 1989, the British stock market started to drop at least a monthprior to a severe selloff in U.S. stocks in mid-October. Sixty years earlier, the 1929collapse in the U.S. market was foreshadowed by a peak in the British stock market afull year earlier.) In 1987, the Japanese market didn't hit its peak until October, whenthe more serious global collapse actually took place.Figure 8.4 shows the Japanese market leading the world markets upward fromtheir late 1987 bottoms. Figure 8.5 shows that the global markets again correcteddownward in October 1989. After a global rally that lasted into the end of that year,the new decade of the 1990s was greeted by signs that global stocks might be rollingover to the downside once again.
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FIGURE 8.4A COMPARISON OF THE THREE STOCK MARKETS FOLLOWING THE 1987 GLOBAL COLLAPSE.THE JAPANESE MARKET RECOVERED FIRST AND PROVIDED MUCH-NEEDED STABILITY TOWORLD STOCK MARKETS.The Japanese Market Led World MarketsOut of Their Late 1987 Bottoms
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FIGURE 8.5ALL MARKETS SUFFERED A MINI-CRASH IN OCTOBER 1989 AND THEN RECOVERED INTOYEAREND. THE BRITISH MARKET STARTED TO DROP SHARPLY IN SEPTEMBER, LEADING THEU.S. DROP BY ABOUT A MONTH. THE FOURTH-QUARTER RECOVERY INTO NEW HIGHS INJAPAN BOUGHT GLOBAL BULL MARKETS SOME ADDITIONAL TIME. ALL MARKETS ARE STARTINC TO WEAKEN AS 1990 IS BEGINNING.Global Markets Underwent DownwardCorrections in the Fall of 1989
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BRITISH AND U.S. STOCK MARKETS
Figures 8.6 through 8.10 provide a visual comparison of the British and the U.S. stockmarkets from 1985 into the beginning of 1990. Although the charts are not exactlyalike, there is a strong visual correlation. Given their strong historical ties, it can beseen why it's a good idea to keep an eye on both. As is often the case with intermarketcomparisons, clues to one market's direction can often be found by studying the chartof a related market. I've already alluded to the tendency of the British market to leadthe U.S. stock market at tops. In Figure 8.6, three examples of this phenomenon canbe seen in the three peaks that took place in early 1986, late 1987, and late 1989.(Going back a bit further in time, U.S. stock market peaks in 1929, 1956, 1961, 1966,1972, and 1976 were preceded by tops in British stocks.)Figure 8.7 compares the British and American markets during 1986. The peak inthe British market in the spring of 1986, and its ensuing correction, coincided witha period of consolidation in the U.S. market. The breaking of a major down trendlineby the British market in December of that year correctly signaled resumption of theAmerican uptrend shortly thereafter.
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FIGURE 8.7A COMPARISON OF THE BRITISH AND AMERICAN STOCK MARKETS DURING 1986. THEBRITISH PEAK IN THE SPRING OF 1986 AND ITS UPSIDE BREAKOUT IN DECEMBER OF THESAME YEAR COINCIDED WITH A MAJOR CONSOLIDATION PERIOD IN AMERICAN EQUITIES.U.S. Stocks (Dow Industrials)1986
FIGURE 8.6A COMPARISON OF THE BRITISH AND AMERICAN STOCK MARKETS FROM 1985 THROUGH1989. SINCE BOTH MARKETS DISPLAY STRONG HISTORICAL CORRELATION, THEY SHOULDBE MONITORED FOR SIGNS OF CONFIRMATION OR DIVERGENCE. THE BRITISH MARKET LEDTHE U.S. MARKET AT THE LAST THREE IMPORTANT PEAKS IN 1986, 1987, AND 1989.U.S. Stocks (Dow Industrial Average)
Figure 8.8 shows the British market hitting its peak in July of 1987, precedingthe American top by a month. In the fourth quarter of that year, the British marketcompleted a "double bottom" reversal pattern, which provided an early signal that theglobal equity collapse had run its course. Figure 8.9 shows both markets undergoingconsolidation patterns before resuming their uptrends together in January of 1989.Figure 8.10 shows the value of market comparisons and the use of divergenceanalysis. The British Financial Times Stock Exchange 100 share index (FTSE) peakedin mid-September of 1989 and started to drop sharply. The American Dow fanesIndustrial Average actually set a new high in early October. Any technical analyst whospotted the serious divergence between these two global stock indexes should haveknown that something was seriously wrong and shouldn't have been too surprisedat the mini-crash that occurred in New York on October 13, 1989. Figure 8.10 alsoshows that the rebound in the American market that carried to yearend in 1989 alsobegan with the upside penetration of a down trendline in the British market. Bothmarkets ended the decade on an upswing.
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FIGURE 8.8A COMPARISON OF THE BRITISH AND AMERICAN STOCK MARKETS DURING 1987. THEBRITISH MARKET PEAKED A MONTH BEFORE AMERICAN STOCKS IN THE SUMMER OF 1987AND COMPLETED A DOUBLE BOTTOM REVERSAL PATTERN AS 1987 CAME TO AN END.
BRITISH AND U.S. STOCK MARKETS
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FIGURE 8.9A COMPARISON OF THE BRITISH AND AMERICAN STOCK MARKETS IN 1988 AND EARLY 1989.AFTER CONSOLIDATING SIMULTANEOUSLY THROUGH THE SECOND HALF OF 1988, BOTHMARKETS RESUMED THEIR MAJOR BULL TRENDS AS 1989 BEGAN.Dow Industrials
Dow Industrials (U.S. Stocks)
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FIGURE 8.10A COMPARISON OF THE BRITISH AND AMERICAN STOCK MARKETS DURING 1989 AND EARLY1990. THE MINI-COLLAPSE IN U.S. STOCKS DURING OCTOBER 1989 WAS FORESHADOWEDA MONTH EARLIER BY A FALLING BRITISH MARKET. AFTER RALLYING INTO YEAREND, BOTHMARKET HAVE BROKEN UP TRENDLINES IN THE NEW DECADE.U.S. Dow Industrials
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FIGURE 8.11A COMPARISON OF THE JAPANESE AND AMERICAN STOCK MARKETS FROM 1985 THROUGH1989. ALTHOUGH THE FIT BETWEEN THESE TWO MARKETS ISN'T AS TIGHT AS THAT BETWEENTHE AMERICAN AND BRITISH MARKETS, THE AMERICAN MARKET IS VERY MUCH INFLUENCEDBY MARKET TRENDS IN JAPAN.U.S. Stocks(Dow Industrials)
British FTSE-100Japanese Stocks(Nikkei 225)
U.S. AND JAPANESE STOCK MARKETS
Figure 8.11 through 8.15 provide a comparison of the American market (utilizingthe Dow Jones Industrial Average) and the Japanese market (utilizing the Nikkei 225Stock Average). The fit between these two markets isn't as tight as that between theAmerican and British markets. Still, there's no question that they have an impact onone another. Figure 8.11 demonstrates the global bull market from 1985 through 1989as reflected in the world's two largest stock markets.In late 1986, the Japanese market underwent a downward correction while theU.S. market was consolidating (Figure 8.12). In the fourth quarter of that year, theNikkei 225 Average broke a down trendline in early November and began anotherupward climb. The alert American chartist might have taken that bullish signal inthe Japanese market as an early warning of more upward movement in Americanshares.We've already mentioned the fact that the American market peaked in August of,1987, two months prior to the peak in Japan. Figure 8.13 shows, however, that the real
global collapse began after the Japanese market began to roll over to the downsidein October of that year. This same chart shows the Nikkei 225 Average completing amajor "double bottom" in February of 1988. This major "buy" signal in Japan turnedout to be an excellent early indication that the global uptrend was in the process ofresuming following the late-1987 collapse. Figure 8.14 shows an upside breakout inJapanese stocks in November of 1988, leading a similar bullish breakout in the Statesalmost two months later.Figure 8.15 compares events in the United States and Japan in 1989. Both marketshit peaks in October and then stabilized. The events of that month show how awarethe world had become of global linkages. The Dow Jones Industrial plunged almost200 points on Friday, October 13th. The world watched through the weekend to seehow Japan would open on Monday morning (Sunday evening in New York). The fearwas that continued weakness in Japan could start a worldwide selling panic. Fortunately, the market stabilized in Japan. The ensuing Japanese rally calmed worldwidejitters and helped spark a global bounce that carried to yearend.
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FIGURE 8.12IN THE FOURTH QUARTER OF 1986, THE JAPANESE STOCK MARKET (REPRESENTED BY THENIKKEI 225 STOCK AVERAGE) ENDED ITS CORRECTION AND PROVIDED AN EARLY WARNINGTHAT THE AMERICAN UPTREND WAS ABOUT TO RESUME.Dow Industrial Average
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FIGURE 8.13THE JAPANESE STOCK MARKET DIDN'T PEAK UNTIL OCTOBER OF 1987 (TWO MONTHS AFTERTHE U.S. MARKET HIT ITS HIGH). HOWEVER, THE SELLOFF IN JAPAN COINCIDED WITH THEGLOBAL SELLING PANIC THAT ENSUED. AS 1988 BEGAN, THE NIKKEI 225 STOCK AVERAGECOMPLETED A MAJOR DOUBLE BOTTOM AND POINTED THE WAY HIGHER FOR THE REST OFTHE GLOBAL MARKETS.
______Dow Jones Industrial Average
Nikkei 225 IndexNikkei 225 Index
In mid-November of 1989, the Japanese market reached a crucial barrier, whichwas the peak set two months earlier. A failure at that important resistance level wouldcarry bearish implications on a global scale. Figure 8.15 shows that the bullish breakout into new highs by the Nikkei 225 Average in late November coincided exactlywith an upside breakout in the American market, which carried the Dow Jones Industrial Average all the way to a retest of its October highs. The ability of the Japanesemarket to rally to new high ground bought the global bull market some additionaltime.While the Japanese stock market was resuming its bull trend, developments inother sectors of the Japanese market were sending danger signals as 1989 ended. Theyen was weakening, inflation in Japan was rising (largely owing to the jump in oilprices), interest rates were rising, and Japanese bond prices were weakening. Froman intermarket perspective, things were beginning to look dangerous for Japaneseequities.Figure 8.16 divides the Japanese markets into the four sectors utilized for intermarket analysis—currencies, commodities, bonds, and stocks. The chart on the upper
left shows the Japanese yen weakening relative to the U.S. dollar as 1990 began.Weakness in the yen helped boost inflation pressures in Japan. To make matters worse,an upward spike in oil prices (lower left) as 1989 ended intensified fears of Japaneseinflation. In an effort to control inflation and help stabilize the yen, Japanese interestrates were raised. (Japanese central bankers had raised their discount rate three timesin succession, activating the "three-steps-and-a-stumble" rule, which was discussedin Chapter 4). The chart on the lower right shows a dramatic plunge in the price ofJapanese bonds. The collapse in Japanese bonds in January of 1990 began to pullJapanese stocks lower (upper right).The Japanese market dropped in eight of the first eleven trading days of the newdecade, losing 5 percent of its value. In just over two weeks, the Nikkei 225 Average gave back about a third of the previous year's gains. The yield on the ten-yeargovernment bond soared to it's highest level since November 1985. Japanese inflation
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FIGURE 8.14A BULLISH BREAKOUT BY THE NIKKEI 225 IN NOVEMBER OF 1988 OCCURRED TWO MONTHS!FORE THE AMERICAN MARKET RESUMED ITS UPTREND IN JANUARY OF 1989.Dow Industrials
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FIGURE 8.15THE JAPANESE AND AMERICAN MARKETS CORRECTED DOWNWARD TOGETHER IN OCTOBER1989. HOWEVER, STABILITY IN JAPAN PREVENTED ADDITIONAL GLOBAL WEAKNESS. THESETTING OF NEW HIGHS IN JAPAN IN NOVEMBER OF 1989 BOUGHT THE GLOBAL BULLMARKETS SOME ADDITIONAL TIME. BOTH MARKETS ARE DROPPING TOGETHER AS 1990 ISBEGINNING.Dow Industrials
Nikkei 225
Nikkei 255
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FIGURE 8.16THE FOUR MARKET SECTORS IN JAPAN-THE JAPANESE YEN (UPPER LEFT), CRUDE OIL (LOWERLEFT), JAPANESE BONDS (LOWER RIGHT), AND THE NIKKEI 225 STOCK AVERAGE (UPPERRIGHT). AS 1989 ENDED, THE WEAKER YEN AND HIGHER OIL PRICES RAISED INFLATIONFEARS IN JAPAN. HIGHER INTEREST RATES TO COMBAT INFLATION ARE PUSHING BONDPRICES LOWER WHICH, IN TURN, ARE HAVING A BEARISH IMPACT ON JAPANESE EQUITIES.Japanese Yen
Crude Oil
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FIGURE 8.17THE COLLAPSE IN JAPANESE BONDS (UPPER LEFT) AS 1990 BEGINS IS PULLING JAPANESESTOCKS DOWN (LOWER LEFT) WHICH, IN TURN, IS SENDING BEARISH RIPPLES THROUGHLONDON (LOWER RIGHT) AND NEW YORK (UPPER RIGHT) STOCK MARKETS.10-Year Yen Bond
Dow Industrials
Nikkei 225
FTSE
Nikkei 225
Japanese Bonds
had risen to 3 percent, which is low by our standards but higher than the Japanesegovernment's target of 2 percent. Besides its weakness relative to the U.S. dollar, theJapanese yen had lost 15 percent against the West German mark in the previous threemonths. The combined affect of these bearish intermarket factors weighed heavilyon the Japanese market. On Friday, January 12, 1990, the Nikkei 225 slid 653 pointsfor its eighth worst performance ever. This bearish action in Tokyo stocks, causedmainly by the collapsing Japanese bond market, sent bearish ripples across the globe(Figure 8.17.)In London that same day, the FTSE-100 (pronounced Footsie) lost 37.8 points,its largest loss in two months. In New York, the Dow Industrials tumbled over 71points. In addition to the bearish overseas action that Friday morning, the New Yorkmarket had troubles of its own. The producer price index for December was 0.7percent, which pushed the U.S. wholesale inflation rate for 1989 up to 4.8 percent,the highest inflation number since 1981. The major culprit behind the surge in the
U.S. inflation rate was the upward spike in the price of oil the previous month. Itseemed clear that the world markets were struggling with two major themes as the1990s began—accelerating inflation and higher interest rates—both factors holdingpotentially bearish implications for global equities.GLOBAL INTEREST RATES
Figure 8.18 compares the bond prices for the United States, Japan, and Britain for thelast three months of 1989 and the first two weeks of 1990. All three bond markets areweakening together. Japanese bond prices are relatively higher than both the UnitedStates and Britain (meaning Japanese yields are lower than the United States andBritain) but are quickly trying to narrow the spread. British bond prices are lowerthan the other two (meaning British bond yields are actually higher than the UnitedStates and Japan). Figure 8.19 shows that British bonds had already been droppingfor some time and revealed a bearish divergence with U.S. bonds.
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MARKETS
FIGURE 8.18A COMPARISON OF JAPANESE, AMERICAN, AND BRITISH BOND MARKETS. ALL THREE AREDROPPING TOGETHER AS 1989 ENDS AND 1990 BEGINS. WEAKNESS ABROAD IS HAVING ABEARISH IMPACT ON U.S. TREASURY BONDS. IT'S IMPORTANT TO WATCH GLOBAL TRENDSWHEN ANALYZING THE U.S. BOND MARKET.
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FIGURE 8.19BRITISH BONDS HAVE BEEN DROPPING THROUGH MOST OF 1989 (BECAUSE OF HIGHERBRITISH INFLATION) AND ARE SHOWING A BEARISH DIVERGENCE WITH AMERICAN TREASURY BONDS AT THE BEGINNING OF 1990. THE WEAKER BRITISH BOND MARKET IS PULLINGUS. BONDS LOWER. TECHNICAL ANALYSIS OF U.S. BONDS SHOULD INCLUDE TECHNICALANALYSIS OF FOREIGN BOND MARKETS.
Global Bond PricesU.S. versus British Bonds
An examination of world interest rates showed a rising global trend. As a result,world bond prices were coming under additional downward pressure. The U.S. bondmarket appeared to be out of line with other global bond markets. As the new decadebegan, the sharp drop in global bond prices finally began to pull U.S. bond priceslower.The U.S. Treasury bond market was lighting a losing battle on many fronts atthe start of 1990. Internationally, U.S. bond prices were trying to buck a global trendtoward falling bond prices. Domestically, the bond market was struggling with risinginflation (commodity markets had recently set a six-month high) and a falling dollar.In the previous section, we showed the value of watching global stock market trendsfor insight into the U.S. market. The same lesson holds true for bonds. It's importantto watch global bond markets for clues to the U.S. bond market. As important as thedomestic U.S. markets are, they don't operate in a vacuum.
GLOBAL BONDS AND GLOBAL INFLATIONFigure 8.20 shows the interplay between U.S. and Japanese bond prices (two charts onthe left) and the U.S. and Japanese stock markets (two charts on the right) during thefourth quarter of 1989 and the first two weeks of 1990. It can be seen that intermarketcomparisons can be applied on many different levels. Compare global stock prices toone another. Notice both stock markets beginning to weaken. Then compare globalbond prices to one another. Notice both bond markets beginning to weaken. Comparebonds to stocks both on a global and on a domestic level. If we accept that U.S. stockprices are influenced by U.S. bond prices, then what influences U.S. bond pricesbecomes very important. If world bond prices are showing signs of moving lower,chances are U.S. bond prices will follow. Technical analysis of global bond trendsbecomes a part of the analysis of the U.S. bond market.
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FIGURE 8.20AMERICAN STOCKS (LOWER RIGHT) ARE BEING PULLED DOWNWARD BY JAPANESE STOCKS(UPPER RIGHT) AND A WEAKER U.S. BOND MARKET (LOWER LEFT) BOTH OF WHICH AREBEING PULLED LOWER BY JAPANESE BONDS (UPPER LEFT) AT THE START OF 1990.Japanese Bonds
Nikkei 225
U.S. Treasury Bonds
Dow Industrials
U.S. stock prices are influenced in two ways by global markets. First, by a directcomparison with overseas stock markets, such as Britain and Japan (which are influenced by their own domestic bond markets). And second, by U.S. bond prices whichare themselves influenced by global bond markets. Discussion of the bond marketand global interest rates naturally leads to the question of global inflation.It's important to keep an eye on world inflation trends. This is true for two reasons. Inflation rates in the major industrialized countries usually trend in the samedirection. Some turn a little ahead of others, and some are laggards. Some rise orfall faster than others. But, sooner or later, each country falls into line and joins theglobal trend. Global inflation peaked as the 1980s began. Japan, the United States,and Italy peaked in early 1980. Britain's inflation rate peaked a few months earlier, inlate 1979. Canada, France, and West Germany turned down in 1981. Six years later,in 1986, global inflation began to creep higher again. Inflation bottomed during thatyear in the U.S., Japan, West Germany, France, Britain, and Italy (see Figure 8.21).Since all countries are influenced by global inflation trends, it's important tomonitor what's happening around the globe to get a better fix on the inflation trend
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FIGURE 8.21A COMPARISON OF GLOBAL INFLATION RATES FROM 1977 THROUGH 1989. (CHART COURTESY OF BUSINESS CONDITIONS DIGEST, U.S. DEPARTMENT OF COMMERCE, BUREAU OFECONOMIC ANALYSIS, DECEMBER 1989.)
in each individual country. If one country gets out of line with the others, it's onlya matter of time before it gets back into line. The second reason it's so important tomonitor inflation around the world is because the direction of inflation ultimatelydetermines the direction of interest rates, which is critical to bond and stock marketforecasting and trading. As you might suspect, in order to anticipate global inflationtrends, it's important to study movements in world commodity markets.
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GLOBAL INTERMARKET INDEXES
Figure 8.22 (courtesy of the Pring Market Review, P.O. Box 329, Washington, CT06794) compares three global measures—World Short Rates (plotted inversely), theWorld Stock Index (calculated by Morgan Stanley Capital International, Geneva) andthe Economist Commodity Index. This type of chart allows for intermarket comparisons of these three vital sectors on a global scale. The world money market rates areplotted inversely to make them move in the same direction as money market prices.When world money market prices are rising (meaning short-term rates are falling),this is bullish for global stocks. When world money market prices are falling (meaning short-term rates are rising), it is considered bearish for global stocks. Money market prices usually lead stock prices at major turning points. As the chart shows, theglobal bull market in stocks that began in 1982 was supported by rising money marketprices. However, since 1987 global stock prices have risen to new highs, while money
FIGURE 8.22THIS CHART COMPARES WORLD SHORT RATES (PLOTTED INVERSELY), THE MORGAN STANLEY CAPITAL INTERNATIONAL WORLD STOCK INDEX (MIDDLE LINE), AND THE ECONOMISTCOMMODITY PRICE INDEX (BOTTOM LINE). INTERMARKET ANALYSIS CAN BE PERFORMEDON A GLOBAL SCALE. (CHART COURTESY OF PRING MARKET REVIEW, PUBLISHED BY THEINTERNATIONAL INSTITUTE FOR ECONOMIC RESEARCH, P.O. BOX 329, WASHINGTON, CT06794.)Global Financial Markets
THE ECONOMIST COMMODITY PRICE INDEX
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market prices have been dropping. This divergence, if it continues, holds bearishimplications for global stock prices.The lines in Figure 8.22 that accompany each index are 14-month exponentialmoving averages. Major turning points are signalled when an index crosses above orbelow its moving average line or when the moving average line itself changes direction. As 1989 ended, the chart shows stocks in a bullish moving average alignment,while money market prices are bearish—a dangerous combination. The chart alsoshows the generally inverse relationship between the two upper lines, representingworld financial markets, and the lower line, representing global commodity pricetrends, which is the Economist Commodity Price Index.THE ECONOMIST COMMODITY PRICE INDEXFor analysis of commodity price trends on a global scale, the most useful index towatch is the Economist Commodity Price Index (published by The Economist magazine, P.O. Box 58524, Boulder, CO 8032