Correlation as Long-Term Pandemic

Fortunately there have only been a handful of pandemics in world history – suffering that begins in one corner of the globe and then radiates outward until everyone gets a taste.

MC Hammer’s world tour and near-domination of the global pop charts in the early 1990’s is one example of how a mistaken group of local record buyers in Oakland, California can ultimately infect people thousands of miles away with aural poison and horrendous fashion choices.  One other notable example would be the Black Death of the 14th Century, which traveled along the Silk Road from China through the Crimea and ultimately killed 100 million Europeans, almost a third of the continent.

I bring all that nastiness up to illustrate the point that global interconnectedness is nothing new, it’s simply been sped up, and attempts to diversify yourself against it will become only more frustrating as time marches on.

The growing correlation between US stocks is likely known to you by now, but how much do you know about the decades-in-the-making trend toward global stock correlations?

The Economist shows us incontrovertible evidence that we are gradually marching toward one big stock market for the entire world:

…the fundamentals of individual economies can be less important to their short-term equity performance than investors might expect. Emerging markets have better growth prospects and sounder public finances than their developed-world counterparts. But those Western investors who have sought to take advantage of these differences can end up feeling disappointed. At the end of August, the MSCI emerging-markets index was down by 10.3% in dollar terms since the start of the year. The developed-world index was down by 5.4% over the same period.

Globalisation is partly to blame. The volume of world trade has risen in every year bar one (2009) over the past decade and now represents 29.7% of GDP, up from 23.8% in 2001. Many developed countries are counting on a surge in exports to boost their own sluggish domestic economies.

I’ve spent a ton of time here explaining that if you own Brazil, you own a derivative of China and that you can’t like China unless you believe their best customers (the US and Europe) can remain somewhat healthy.  I’ve also mocked the notion that we can “ring-fence” ourselves in from disaster or that any large economy can be decoupled from the realities of the rest of the world.

There is no ring-fencing, there is no decoupling, there is no immunity to a large-scale economic meltdown or market panic.  Not for you and not for anyone else, I don’t care what geographic mix your ETFs represent.

My friend Peter Brandt, who has been watching decades, has reached the conclusion that we are in all one market as well, coincidentally he has a post out that morning on the topic.  Says the legendary trader:

It has come to be known as the “risk-on/risk-off” or “all-one-market” phenomena in global markets. It is a situation where seemingly unrelated markets have taken on an historically high correlation. Individual markets seem to be the proxy for all other markets.

I have witnessed periods in the past when unusually strong correlations existed for months and months. But, I have never experienced the level of correlation we have lived with as traders since 2008.

This doesn’t mean to ignore geography when planning a portfolio.  No, the takeaway is not to rely on geography – because when the going gets rough, it’s all one market.  On top of that, even in periods of calm we are headed there anyway – globalization of trade means globalization of stocks in the long run.


All in the Same Boat (Buttonwood)

An excellent example of the “all-one-market” phenomena (Factor)


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