Mastering Intermarket Analysis | CFA Level I Portfolio Management

Hey, welcome back, future finance wizards! We’re wrapping up our technical analysis series with a thrilling dive into intermarket analysis and how it’s applied in portfolio management. Grab your calculators and let’s jump in, shall we?

What is Intermarket Analysis?

Intermarket analysis is like the Sherlock Holmes of asset relationships. It’s all about dissecting how different asset classes interact. The ultimate goal here? Spotting market trends and predicting when those trends might do a U-turn.

Often, this is achieved by plotting the price of one asset class against another – a strategy known as relative strength analysis.

Let’s consider an example where we plot the relative strength of the S&P 500 against gold prices. In the first half of our chosen period, gold shines brighter. However, there’s a clear trend reversal afterwards, with the S&P 500 outperforming gold. This trend shift hints that it might be time to move funds from gold into US stocks.

Applying Intermarket Analysis in Portfolio Management

So, you’ve spotted a trend and decided to shift from gold to US stocks. The question now is, which sector do you invest in?

This is where intermarket analysis takes another bow. It’s not just about choosing between asset classes, it can also guide us to the most promising sectors within the equity market.

The magic trick here is to analyse each sector against a broad market index, like the S&P 500, and find the sector that has the best performance potential. And yes, you’ve guessed it, we use our good friend, relative strength analysis again.

Imagine a chart plotting the performance of tech stocks relative to the broad index. You notice that tech stocks have started to outshine the broader market after a period of underperformance. Assuming this trend continues, it could be smart to go heavy on tech stocks.

Why Relative Strength Analysis is a Game-Changer

Simply put, relative strength analysis is a power tool for spotting relative trends across international markets, asset classes, and specific sectors. It’s like having X-ray vision when you’re deciding which countries, regions, asset classes, or sectors to overweight in your portfolio. Plus, it can be used alongside charts and indicators to pinpoint specific stocks to invest in.

Technical Analysis (TA) techniques can also be applied in both top-down and bottom-up portfolio management approaches. For the former, intermarket analysis helps identify potential areas of investment. For the latter, managers use TA signals to identify specific securities to trade in, without considering market, industry, or economic trends.

Interestingly, TA can also play a supporting role in fundamental portfolio management. Managers decide the portfolio allocation and specific securities based on fundamental analysis, but might use TA techniques to nail the timing of buying or selling securities.

And there you have it! We’ve finished our series on technical analysis. It’s not a colossal part of the exam, so don’t get too lost in it. Take a breather, try out the quiz, and we’ll catch up in the next lesson. Keep crunching those numbers!