First off, Happy Independence Day!

After yet another week where the benchmark S&P 500 printed an all-time weekly high, what better way to celebrate this great nation’s Independence than spending it with friends and family.

Recently, the market has been stronger than the average seasonal pattern would typically warrant at this time of year.

But that did not stop me from anticipating a period of “melting higher” across the major US indices this week.

I’m about to show you some of the backtest and intermarket analysis tools I used to make this determination.

What is Intermarket Analysis?

In layman’s terms, intermarket analysis is a method of market research that monitors cross-asset relationships for any signs that a change in market direction might be coming.

For example, you may have come across headlines in recent months about how rising interest rates earlier this year had put some pressure on US equity prices, particularly large technology companies.

Or you may be aware that a surging dollar usually puts pressure on commodities prices.

Essentially, these are all intermarket forces at work, and learning how to measure these forces can become one of the most valuable skills a trader can develop over his or her career.

What are some of the intermarket signals that have been supportive of US equities in recent days?

When it comes to measuring intermarket signals, there are numerous methods that can be employed.

For today, we’re going to focus on relative strength.

Not relative strength as in the Relative Strength Index (RSI) momentum indicator, but two markets that are measured relative to each other using a simple ratio.

The chart below shows a couple of the more important intermarket relationships to measure when trying to gauge risk appetite within the equity market. In other words, how much confidence do investors have to take on bullish risk.

Trust me when I tell you that there are countless other relationships that can be measured. For today, though, we’ll keep it simple and start with the basics.

On this first chart, the top panel shows the S&P 500, while the bottom two panels show the Consumer Staples sector vs. the S&P 500 and the Utilities Sector vs. the S&P 500.

Figure 1

Starting from the left, you’ll notice on the chart above that during the Covid sell-off, the ratios in the two bottom panels are rising.

What you are seeing there is both the Consumer Staples and Utilities Sectors outperforming the S&P 500 during that risk off period in the market.

You see, the Consumer Staples and Utilities Sectors contain stocks that are considered to be less risky investments, because of their ability to generate income during the worst economic environments.

Think of it this way, if you think back to the Covid crisis, you probably remember continuing to buy groceries and paying your electric and water bills.

Well, these are the kinds of companies we’re talking about here.

Next, as we move toward the right of the chart, you’ll notice that these ratios began to fall after the peak of the crisis in March 2020, as investors slowly began to regain their appetite for riskier stocks.

Fast forward all the way to this week and you’ll notice that both of these ratios are at or near multi-year lows as the S&P 500 is at all-time highs.

It’s measures of risk appetite like this that should be part of your analysis when trying to determine what the risk environment is like, which will then help you stay on the right side of the market.

Like so many other indicators, when we start to see these lines diverge against the stock market’s prevailing trend is when we start to get early indications that the market’s risk appetite is changing, and we’re just not seeing that right now.

Lastly, it’s also worth highlighting that history tells us the trading environment in the week leading up to and following the 4th of July holiday tend to have a bullish tilt.

This can be seen on the table directly below.

Figure 2