Green shoots of recovery?

More and more articles are heralding a recovery in the markets as underway, and with this week's G20 meeting perhaps some confidence is returning. Indeed as of writing this, the S&P 500 Index is up just over 18% from the lows of early March. I thought it might be useful from a risk perspective to spend a little time examining whether there was any indication of any return to normality of the asset class correlations covered previously on this blog.

I therefore considered an article from the WSJ (Markets having a swinging time) as the basis from which to look at the relationship between multiple asset classes and their recent movement : Equities (5 global regions), Treasuries (US 1-3Yr & 10Yr+) and commodities (Oil, Gold). With diversification being the grail that those of us interested in risk are looking for, we would hope to see a reduction in correlations between these classes.

I looked at the daily correlations of the indices over the last 10 years as my datum, then considered the correlations since September 15, 2008 (Lehman news came to market) and the correlations of the last 60 days. The matrices below show the differences in between the two shorter periods and the datum (click to enlarge):



From a U.S. perspective, the correlation with Europe remains well above the norm and, with the unified approach to fiscal that is being trumpeted from London at the moment, I do not see that changing in the near future.

More interestingly, Emerging Markets and the Pacific Rim are becoming even more correlated with the U.S. (up to 60% over the last 60 days), and while Japan may be starting to return to normal there seems to be no diversification benefit to be had anywhere across equities.

In terms of commodities, the oil price correlation with the S&P 500 is at a 10 year high leaving Gold as the only area of poteantial relief here. Treasuries look to have returned to their long term correlation levels but I think it is too soon after the implementation of the recent quantitative easing to accept these numbers too quickly.

We may well have seen the bottom of the market, but there is no current evidence that any kind of decoupling has taken place that could be leveraged from a risk perspective. The call would seem to be "in or out" as opposed to "where and how much"!

Get new Taking Risk entries delivered to your e-mail as they are posted.