The Great Correlation Collapse

  1. The Great Correlation Collapse

    As flat as the Kansas prairie. That’s one way to describe a volatility chart for the equity markets in 2017. Seemingly absent from Wall Street this year, volatility indexes are trading near record lows and rarely getting close to long-term averages. Our human nature likes a smooth ride, whether in a car or in our investments. For the former, we can thank good road and suspension engineers, but in the latter it is often less obvious. We should look around a bit more to find out where to direct our appreciation. At the same time that volatility has bottomed, equity indexes have hit dozens of records through the year in a mostly linear way. According to LPL Financial, the S&P 500 recently set a record for how long it has gone without a decline of 3%. As of November 14, it has gone 50 sessions without a drop of 0.5%, a stretch last seen in 1968. And for the year it has experienced only eight sessions where the closing price changed at least 1%, an unusually small number of occurrences. Nothing to see here, please move on. It seems our good fortune comes largely from the collapse in equity market correlations. Correlation refers to the degree to which two different securities, or groups of securities, move in tandem. A correlation of 1.00 means both assets move perfectly in tandem. A correlation of 0.00 means two assets move in completely opposite directions. According to DataTrek, Research, between 2012–2016, average sector correlations were 0.81; last month they…

  2. Global warming

    We lifted the title for this post from Ed Yardeni who runs Yardeni Research, an investment strategy research firm. Ed offers a checkup on an economic theory debate that has been simmering for several years in the economics community, nicely tucked away from the wider world. The crux of the issue is finding an explanation for the frustratingly slow pace of economic recovery coming out of the crisis of 2008. Emerging from the ensuing recession, the U.S. economy was forecasted to grow in the same 3-4% range as in other recoveries. We crossed 3% a quarter here and there, but overall annual growth rates hovered around 2%. Aggressive forecasts were constantly scaled back, but the answers to the shortfalls weren’t obvious. In 2013, Larry Summers, a Harvard professor, gave a speech that suggested the United States was stuck in an extended period of secular stagnation. This is the idea that our economic problems weren’t a product of the business cycle, but are permanent drags on the modern economy. The term was coined by economist Alvin Hansen in 1938 to explain the sluggish recovery throughout the preceeding decade. The core of Hansen’s thesis stated that slower population growth and a lower speed of technological progress would permanently thwart economic growth. World War II helped to change these circumstances, but a long peacetime expansion that followed put the theory on the shelf to gather dust, until now. Kenneth Rogoff, also a professor at Harvard, sits on the other side of the issue, dismissing secular stagnation as a…

  3. What are you afraid of?

    In 2016, Chapman University, a private, non-profit university located in Orange, California, produced its third annual survey of American Fears. The survey asked respondents about 65 fears across a broad range of categories including fears about the government, crime, the environment, the future, technology, health, natural disasters, as well as fears of public speaking, spiders, heights, ghosts and many other personal anxieties. The greatest number of respondents, 61%, report a fear of corruption of government officials. The rest of the top ten are represented between 35% and 41% of respondents. These include becoming victims of a terrorist attack, loss or illness of a loved one, economic/financial collapse and even fear of the Affordable Health Care Act, itself an effort to alleviate the fear of having no health insurance. That’s a lot of fear. The composition of the list also presents another perspective. Just how many of these fears can be addressed; can we do anything about them to mitigate our anxiety? For example, what can we do about corruption of government officials? Arguably, such untrustworthy officials can and should be dealt with at the voting booth. Joseph de Maistre, a French lawyer, diplomat, writer and philosopher who died in 1821 is credited with the quote, “In a democracy people get the leaders they deserve.” How about the fear of becoming a victim of terrorism? We could stay home all day in order to reduce our exposure to the unfathomably small probabilities, but that is hardly practical to help us navigate life successfully. What about the…

  4. Who is Jerome Powell?

    That was a late inning surprise. Yesterday, President Trump announced that Jerome Powell would be his choice to lead the Federal Reserve starting next February. Powell has been a Fed Governor since his nomination in 2012 by President Obama, so he is expected to garner bipartisan support in the Senate. Prior to the leaks that started last week, Powell did not seem to be the front-runner for the job – the highest odds we assigned to his becoming Fed Chair never exceeded 35%. Therefore, comparatively little was written about his past views and actions. As a Governor, he didn’t give a lot of speeches, his wasn’t the loudest voice in the room and he never dissented over 44 meetings. He appeared to be a loyal soldier. Powell would be the first Fed Chair without a PhD in Economics since Paul Volcker in the 1980’s, thus we lack a body of published research from which we can glean his likely outlooks and views. He does bring a respected body of public service and private business experience that should serve him well. Notably, markets will like the appointment for the continuity. What evidence does exist suggests he will maintain the path set by Janet Yellen in raising rates, diminishing the level of assets on the Federal Reserve balance sheet, supporting some level of regulatory rollback and otherwise doing little to upset monetary policy. He is not expected to rock the boat. Click here to see a Bloomberg article that we think does the best job of describing…