We've already looked at the high correlation within the stock market that has caused most issues to move together as a herd. By now it should also be clear that this correlation is evident even across asset classes, providing a binary market where risk is either on or off.
Below is a grid covering 31 asset classes, showing through a color gradient, their rolling monthly correlation to each other for the past 12 months (through August 2010). A quick glance to the top left hand side shows how correlated world stock markets have become.
Click for massively large version in a new tab:
It doesn't really matter whether you are holding the S&P 500, small caps, European equities, emerging markets or Asian equities. Everything pretty much moves in lockstep, denigrating any granular decision making within that area. That leaves us with precious few assets that are dancing to their own tune (bluish lines going across the grid). These uncorrelated assets are: gold (including precious metal equities), bonds (government and corporate but not high yield) and the Yen/US cross. These are the only places you can treat as a refuge. Energy, base metals, and hedge funds provide no diversification or safe haven benefits.
This is why I spend a lot of time and energy trying to time the various markets, instead of picking individual stocks. At this point, you could be an amazing stock picker and bottom up analyst but it will do very little good as the tide will lift all issues irrespective of their merit. I don't doubt that short-term trading is still relevant and profitable but I'm referring to fundamental, value oriented - Graham & Dodd (or Warren Buffett) - style investing.
You can use the grid several ways. One way to use it is to fine tune your long-term investment account. Check what you're heavily invested in at the moment and find what asset class you're missing to balance it out. Of course, diversification in and of itself is useless if all you're doing is diluting your performance just to shave off some variability along the way.
Anyway, take a look at it and let me know if any insights pop into your head.bond, commodities, correlation, equities, gold, hedge funds, stock, yen
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