One of the odder aspects of the financial crisis was the full on correlation of various asset classes. During October 2008, normally non-correlated assets began moving in lockstep. As the psychology of the crisis shifted from denial to panic, stocks, bonds, commodities all moved towards a correlation of 1.0.
During the bull market from 2002 to 2007, a period when S&P 500’s price and profits doubled, the correlation averaged 0.15. As correlation moved higher — a relatively rare occurrence — it bode poorly for equity prices. (This has been the case often in the past during crises).
Bloomberg has the details:
“For the first time since the financial crisis started, U.S. shares are moving independently of the bond market, a sign that profits and valuations are guiding investors more than concern about the economy.
The 30-day correlation coefficient measuring how often the Standard & Poor’s 500 Index moves in tandem with 10-year Treasury yields fell to minus 0.42 from a record 0.89 in June, data compiled by Bloomberg show. Readings of 1 indicate prices are moving together, while zero shows no link and minus 1 means they are going in opposite directions. Stocks and debt are ending a lockstep relationship that began in July 2007 and lasted through the worst recession since the 1930s. . . .
The S&P 500 plunged 4.7% and yields on 10-year Treasuries tumbled 33 basis points on Sept. 15, 2008, after New York-based Lehman Brothers Holdings Inc. filed for bankruptcy. The correlation jumped to 0.83 on Oct. 6, 2008, as the financial crisis intensified, reaching the highest level since a month after the Iraq War began in 2003.”
The break down in correlations had an impact during the Q’s earnings period. For the first time in three years, companies beating estimates rallied and those that missed fell on average.
Greed Beats Fear With Stock-Bond Correlation Falling
Bloomberg, Nov. 22 2010
Cash Best as Record Correlation Hints Herd Collapse (June 29 2010)