Equity Correlations Haven’t Spiked Above 2011 Or Last September’s Levels by Eric Bush, CFA, Gavekal Capital Blog
A well observed characteristic in the equity market is that when volatility spikes (or markets go down and usually these two occur hand in hand) correlations among stocks spike as well. Consequently, it doesn’t give investors very many options to hide. In the 2011 sell-off, the 65-day correlation between US stocks and the MSCI World Index spiked to 0.79. The correlation between developed market stocks in general and the MSCI World Index hit a high of 0.61 in 2011. In September’s sell-off, the 65-day correlation between US stocks and the MSCI World Index rose to 0.68 and the correlation between developed market stocks in general and the MSCI World Index hit a high of 0.51 in 2011. Currently, the 65-day correlation between US stocks and the MSCI World Index is at 0.55 and the 65-day correlation between developed market stocks in general and the MSCI World Index is at 0.40. Granted, the 65-day correlation in both cases does look like it will continue to rise but unless shorter-term correlations significantly increase, it seems like they won’t take out the levels made in September. The reason we feel confident in saying this is because the 20-day correlations haven’t surpassed levels hit in either 2011 or in last September. The 20-day correlation between US stocks and the MSCI World Index made a high of 0.87 in 2011 and 0.81 last September. So far in this sell-off, the highest 20-day correlation was 0.68 on 1/11/2015.
Lastly, for investors that are looking for lower correlations to other developed world stocks one should look towards Japan. Japanese equities consistently have much lower overall correlations to the MSCI World Index than US or European stocks. In the chart below, we plot 20-day, 65-day and 200-day correlations between Japanese stocks and the MSCI World Index. While the US regularly has a correlation above 0.50 to the MSCI World Index (which intuitively makes since US stocks make up over half of the MSCI World Index constituents), Japanese stocks rarely ever have a correlation of 0.50 and usually have a correlation between 0-0.20 to the MSCI World Index.