The General Trend Remains Towards increased Cross Asset Correlation (which is no good from a diversification and risk consumption point of view). This is why holding some (well chosen) shorts will now add diversification. - [1 ] The normally solid positive positive correlation between the stock market (risk appetite) and dollar yen remains upside down, and actually going further away from its 5y average, meaning dollar yen now is negatively correlated with stocks (which until the last couple of days have been going up). This remains the reflection of the structural nature of the current dollar weakness. JPY is being bought against USD irrespective of risk appetite consideration. - [ 2] Gold is now very largely positively correlated with stocks (+65% vs. -10% on average over the last 5years) which is fairly unusual (and still related to the dominating factor of dollar weakness). Gold and stocks rallying at the same time fits nicely with nascent inflation fears and gold likes inflation as much as it likes to go higher on dollar weakness...That being said, this week, the positive correlation has increased because both gold and stocks have been going down... - [ 3] Over the past week, bonds and stocks have nearly stopped being negatively correlated (a problem for risk consumption) contrasting with the historical norm. This is the biggest change of the week. Last week it was extreme negative correlation because stocks were rallying as bonds sold off. Now, bonds sold off further but stocks are taking notice..A bond crash as we auggeated last week ... if it happens would certainly bring stocks down with them a la 87. - [ 4] EM and the s&p are correlated 1 to to 1 (in contrast with the eurostocks/us stocks correlation that keeps weakening.. because european stocks suffer from a wekening dollar. This suggests continued relative strength of EM markets as good substitude to US stocks at the moment as European shares continue to lagg on dollar weakness. EM markets care much less about dollar weakness, looking at commodities and the global recovery for cues as to where to go.
Why does correlation matter and why choosing the S&P500 as anchor? * Just like the earth turns around the sun, most financial assets turn around the S&P500 not least because the S&P500 serves as a performance boggy for most asset managers. Most of them will trade the s&p500 to increase or decrease beta (market risk) exposure. * Another reason is that the s&p500 conditions bull/bear perceptions in equities, risk appetite, wealth effects and to a large extent the health of the (world) economy. * Last but not least, cross asset correlation (and volatility) determines diversification benefits which is a key parameter in any risk model, starting with ‘value at risk’ which is used extensively in the asset management industry to construct portfolios. In one word or two, the higher the correlation the higher the “var”. In a low yield and low volatility environment, diversified portfolios are constructed and often leveraged such as in ‘risk parity’ portfolios. Whenever positive correlation increases across asset classes, value-at-risk numbers increase, all other things remaining equal. And whenever var models shout, risk and portfolio managers listen and they respond by reducing leverage and liquidating assets. Hence the interest to track correlation patterns (the same way as volatility which is the second most important variable in value at risk models) so as to anticipate the impact on value at risk risk and how portfolio managers are likely to respond. For a daily update and interpretation of these different parameters and much more, consider a subscription to the Bentin Daily, our premium research service. Important Disclaimer © Copyright by BentinPartner llc. This blog is not intended as a recommendation, an offer or solicitation for the purchase or sale of any security or underlying asset referenced herein or investment advice. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situation, investment horizon and particular needs. This blog does not include information tailored to any particular investor. It has been prepared without any regard to the specific investment objectives, financial situation or particular needs of any person who receives this report. Accordingly, the opinions discussed in this blog may not be suitable for all investors. You should not consider any of the content in this report as legal, tax or financial advice. The data and analysis contained herein are provided "as is" and without warranty of any kind. BentinPartner llc, its employees, or any third party shall not have any liability for any loss sustained by anyone who has relied on the information contained in any publication published by BentinPartner llc. The content and views expressed in this report represents the opinions of Marc Bentin and should not be construed as guarantee of performance with respect to any referenced sector. We remind you that past performance is not necessarily indicative of future results. Although BentinPartner llc believes the information and content included in this report have been obtained from sources considered reliable, no representation or warranty, express or implied, is provided in relation to the accuracy, completeness or reliability of such information. This blog is also not intended to be a complete statement or summary of the industries, markets or developments referred in this blog.