The Link Between Bonds And Stocks
by John J. Murphy
Intermarket analysis is based on the premise that all markets are linked. Last month, technical
trailblazer John J. Murphy explored the inverse interrelationship between commodity and bond prices;
this month, he examines the relationship between bonds and stocks and how bond prices can be used as a
leading indicator for stocks. Take a look.
Bonds and stocks usually trend in the same direction. However, it's not as simple as that. At important
turning points, bond prices usually turn ahead of stocks. At bottoms, bond prices usually turn up before
stocks. At tops, bond prices usually turn down before stocks. Viewed in that fashion, bond prices can be
used as a leading indicator for stock prices.
The tendency for bond prices to turn ahead of stocks also explains the apparent "decoupling" that often
occurs when bonds and stocks trend in different directions. What may appear to some to be a
"decoupling" is an early warning to others who are aware of the interrelationship between the two. A
dramatic example of that phenomenon occurred in 1987, when bonds plunged during April (coinciding
with a strong upturn in commodity prices), four months before the August peak in stocks. During mid
991, bonds turned up six months before stocks. Figures 1 through 3 compare bonds futures with the
Standard & Poor's 500 index over three timespans beginning shortly after the 1987 crash.