December 16th, 2011

World Stock Markets are Correlated

If thanks are in order then it’s from me to all of you.  It’s because of you that I take the time to be analytic, to look at the forest instead of at the trees, to look in places and directions that are different than those we regularly hear and read about in the business media.  For example, when attempting to divine our market’s future we often see with blinders on.  We look at individual stocks, we look at the S&P 500 and we look at our economy but we don’t often to look at what might be happening to other markets around the world, something that’s relatively easy to do these days because of ETFs.  I scanned those ETFs and was surprised by what I found.

In an article in today’s Reuters, “Stock markets have become so highly correlated to one another that it can feel like a one decision world: in or out.  The massive and global nature of the series of related financial crises since 2007 have robbed diversification of much of its value. Nearly every asset class is now closely correlated.”  The article quotes a study by Societe Generale that “a massive increase in correlation, from about a .5 correlation in the early 1980s to nearly .9 percent in recent months.”

The same seems to be happening to the returns generated by the “Herd”, the hedge funds who get paid huge fees to generate better than average returns on the large sums of money they manage.  According to Reuters, “these correlations in the 1990s were at about the .6 level, now they are topping the .9 mark, begging the question of why investors are paying expensive managers.”

We can’t explain the new correlation or, for that matter, care to know the cause.  The point is that “Diversification was the low hanging fruit of wealth management” and due to the increase in international trade, it’s no longer available.  We can see it in the ETFs of stock markets around the world; I could have picked more from the 30 some ETFs but you get the picture (click on image to enlarge):

  • Brazil: a possible double-head reversal top
  • Hong Kong; a surrogate for various Asian markets, including China
  • EAFE: 22 developed countries in Europe, Australasia, and Far East other than US and Canada
  • S&P 500: an argument can be made for forcing a reversal top, in this case an emerging head and shoulder formation, on the S&P 500 Index

We’ve spent a lot of time and emotional energy trying to figure out in which direction the market will break out of the trading range. We waiver back and forth depending on the news out of Europe. We turn optimistic when we finally start getting a little bit of positive news on our economy (like “things aren’t getting worse” or “things are slowly getting better”). Bottom line ….

  1.  in today’s market, diversification gives way to market timing and
  2. we might fair no better than other world markets and have to endure a further 20-25% decline before we’ll see a bull market trend begin.

Like it or not, truly, today We are the World.

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