The Shifting Sands of Correlation

- The macro world dominates stock prices. "The relationship between small, mid and
large cap indices has only climbed further in the past quarter, with the S&P 600’s correlation coefficient climbing to 0.99 over the past three months when compared to the S&P 500 and the S&P 400’s coefficient rising to 0.97, compared with the past year’s 0.94 and 0.90, respectively. Moreover, these figures are meaningfully above the past 10-year levels implying that broader issues are affecting stock price moves and unique bottom-up stories are having far less impact, possibly reflecting the lack of money flows into US equities."
- Commodity prices have become even more highly correlated except for gold. "The CRB index’s coefficient spiked to 0.88 over the last 90 days, sharply above the 0.30-0.35 range seen looking back five and 10 years, most likely being the result of a keen focus on global economic potential. In contrast, gold remains the outlier with an inverse correlation of 0.65 recently, reversing its direct relationship of the last year. Some of this change is probably a sign of fiat currency debasement fears or the ongoing and often heated inflation/deflation debate."
- The trade-weighted dollar has become a tad less impactful to stocks. "While the
dollar’s inverse effect on the MSCI Emerging Market index is now much more inline with historical averages, it has shifted markedly in the past year. But the dollar’s relationship with the VIX volatility index has spiked and is far less sensitive to commodities than may be perceived. Similarly, the greenback’s correlation with 10-year Treasury bonds may not be as high as one might consider at first blush."
- A fix on the VIX is not that critical. "Many tend to see the VIX as the “fear gauge” but one would argue that gold is a defensive investment and thus should have a meaningful relationship with the VIX and that generally has not been the case. In contrast, there is a rising correlation with oil but the relationship with stocks as well as the 10-year Treasury is below levels seen over the past 10 years."
- Small cap stocks correlation has swung wildly. "The S&P 600 index’s correlation data have moved around a fair amount in the last couple of years. Specifically, the dollar is having more impact but in an inverse fashion while maintaining a strong directional relationship with commodities and emerging market stocks. Thus there is very little diversification being achieved when one buys small cap names, emerging markets and commodities even if it is thought of as spreading out across different asset classes."

Citigroup Correlation Quarterly 2010Q3

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