Sunday, February 8, 2015

Current correlation and diversified stock/bond portfolios




Correlation tells the story of what has happened to diversified portfolios in the last few months. The correlation between stocks and bonds has moved from close to zero to a strong negative. The most negative in the last few years. 

The bond market has actually been doing well year to date until this week. It was clearly telling us that there was a potential slowdown in growth or at least a further decline in inflation expectations.  The dollar/stock relationship has increase significantly and is at all time highs for last three years. The gold/stock correlation has also fallen from positive to negative levels and is consistent with the bond move which suggests this is related to inflation expectations. The VIX/stock correlation has not  changed and is the only stable relationship.

These extremes are not good for diversified investors because they are unlikely to continue which means a reversal in asset class trends.The chart is from the new NYU Stern School Volatility Center (VLAB).  The changes in correlation especially for stock/bonds means that returns for long-only diversified portfolios will be relatively stable and will be bracketed by stock and bond returns. This suggests that GTAA and global macro managers will likely have relatively stable returns. 

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