Deflationary Relationships Murphy notes that

[b]Deflationary Relationships[/b]

Murphy notes that the world shifted from an inflationary environment to a deflationary environment around 1998. It started with the collapse of the Thai Baht in the summer of 1997 and quickly spread to neighboring countries to become known as Asian currency crisis. Asian central bankers raised interest rates to support their currencies, but high interest rates choked their economies and compounded the problems. The subsequent threat of global deflation pushed money out of stocks and into bonds. Stocks fell sharply, Treasury bonds rose sharply and US interest rates decline. This marked a decoupling between stocks and bonds that would last for many years. Big deflationary events continued as the Nasdaq bubble burst in 2000, the housing bubble burst in 2006 and the financial crisis hit in 2007.



The intermarket relationships during a deflationary environment are largely the same except for one. Stocks and bonds are inversely correlated during a deflationary environment. This means stocks rise when bonds fall and visa versa. By extension, this also means that stocks have a positive relationship with interest rates. Yes, stocks and interest rates rise together.





Obviously, deflationary forces change the whole dynamic. Deflation is negative for stocks and commodities, but positive for bonds. A rise in bond prices and fall in interest rates increases the deflationary threat and this puts downward pressure on stocks. Conversely, a decline in bond prices and rise in interest rates decreases the deflationary threat and this is positive for stocks. The list below summarizes the key intermarket relationships during a deflationary environment.

An INVERSE relationship between bonds and stocks
A POSITIVE relationship between interest rates and stocks
An INVERSE relationship between commodities and bonds
A POSITIVE relationship between commodities and interest rates
A POSITIVE relationship between stocks and commodities
An INVERSE relationship between the US Dollar and commodities