Tuesday, June 30, 2009

Bloomberg: Correlation Among Asset Classes Highest Ever

While I own a lot of cash it is for different reasons than this story; I am simply awaiting a break out of this months long range one way or the other. However, I completely agree with the massive correlation among asset classes. "Herd mentality" is a great way to describe much of the trading, although I much prefer "lemming action". It's quite wonderful when almost everything moves up together... not so much when it goes the other direction.
  • Investors are moving in lockstep like never before, driving up stocks, commodities and emerging markets and risking a replay of last year, when they all plunged the most since World War II.
  • The Standard & Poor’s 500 Index, whose increase in the past three months was the steepest in seven decades, is rallying in tandem with benchmark measures for raw materials, developing- country equities and hedge funds.
  • The so-called correlation coefficient that measures how closely markets rise and fall together has reached the highest levels ever, according to data compiled by Bloomberg.
  • The herd mentality threatens to leave investors with no refuge amid signs that the worst U.S. recession since 1958 isn’t abating. While bulls say it makes sense that markets climb together after the S&P 500, copper and oil lost more than 38 percent in 2008, RiverSource Investments LLC and Harris Private Bank are telling clients that diversification strategies to smooth out returns won’t work. They suggest shifting money to cash and bonds on concern gains will evaporate.

  • “If everything’s moving in the same direction, you can’t build a portfolio that has varying degrees of risk,” said David Joy, chief market strategist at RiverSource, which manages $125 billion in Minneapolis. “If we don’t start to see tangible evidence of economic improvement, there’s enough tentativeness among investors that they may be quick to retreat.”

Tandem Moves
  • The S&P 500 has added 37 percent from a 12-year low in March, increasing on 56 percent of the days during that span. The Reuters/Jefferies CRB Index of commodities has advanced 27 percent from its trough, rising 58 percent of the time.

  • The gains pushed correlations between the indexes to 0.74 this month, based on percentage changes over the past 60 days. That’s the highest in at least five decades, data compiled by Bloomberg show. A reading of 1 means two assets move in tandem, while zero means no relationship. The correlation never rose above 0.66 before this month.

  • Gains in U.S. stocks have mirrored those in crude oil as never before, with correlations above 0.7 this month, according to data compiled by Bloomberg. For the MSCI Emerging Markets Index, the relationship is the tightest since Russia defaulted on its debt in 1998. The correlation between the S&P 500 and an HFRI index of fund of hedge funds, based on percentage changes in the past 12 months, reached 0.5 in April for the first time in almost five years, monthly data compiled by Bloomberg show.

  • I have a lot of friends in the hedge-fund world; they talk to each other and have many of the same trades,” said Nick Sargen, chief investment officer at Fort Washington Investment Advisors in Cincinnati, which oversees $27 billion. “These are people who say, ‘I see a pattern, and I’ve got to jump on.’”

Oh Harry...

  • Harry Markowitz, 81, who won the Nobel Prize for economics in 1990 for his work on portfolio theory, says that last year’s collapse reinforces his view that even the most unlikely outcomes are possible in any year. “The thundering herd is still with us,” said Markowitz, a professor of finance at the Rady School of Management at the University of California, San Diego. “Nature draws into a bushel basket full of returns and finds a next return every year, and I believe there’s another 1929 somewhere in that bushel basket. 2008 was not a refutation, it was a confirmation.”

In summary - (almost) everything goes up, or (almost) everything goes down... something we've been saying since spring 2008. Individual stock picking or even commodities is less and less useful; just be "in the market" in some manner during good times and "out of the market" at bad times. The instrument of choice is less and less relevant.

  • There’s nowhere to hide,” said Joseph Mezrich, the head of quantitative research at the U.S. brokerage unit of Nomura Holdings Inc. in New York. “The problem of correlations is growing, and I don’t think it goes away.”

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