In recent commentaries we’ve written about the three phases of a bull market and how and why the final phase evolves as it does. Valuations, sentiment and market structure all explain why markets take a dramatic upward turn in the final phase after relatively stagnant performance in the previous phase. These are the “micro” behind why a bubble emerges in the final phase. Today we want to look at the intermarket driving forces behind the emergence of a bubble.
We often write about intermarket analysis, which is an incredibly useful and actionable form of technical analysis. The greater the bubble, the greater role intermarket relationships play in the formation of the bubble. Essentially, for a large market to form a bubble, capital needs to flow out of various asset classes and into that particular market.
Here is a quick example of the technology bubble in the 1990s. We plot the Nasdaq, Bonds and Commodities (the three major asset classes). The Nasdaq accelerated from 1994 to 2000. In the same time period, Bonds were volatile but didn’t make much progress. Commodities were in a nasty bear market from 1996 to 1999. Note that Bonds surged from 1990 through 1993, a period in which the Nasdaq climbed slowly. Furthermore, from 1993 to 1996, Commodities experienced a very strong bull market
….read more HERE
