Correlations

To our surprise, the measure that most closely correlated with real-GDP growth on a one-year time horizon is the rarely mentioned Treasury spread for the 5-Yr./3-Mo.

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The 10-year Treasury yield has absorbed the past two months’ worsening inflation numbers by going exactly “nowhere.” Bond investors seem to be all-in on the Fed thesis that the inflation pickup is just transitory.

During the recent consolidation, however, the Treasury yield showed a subtle change in character—one that suggests there might be more inflation paranoia than meets the eye. The 10-year yield’s daily correlation with stock price movements flipped negative, and then plummeted toward a 21-year low. 

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Economists argue the best thing the stock market has going for it is the continuation of the U.S. economic expansion. Maybe.

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While investors in Value, Small Caps, and especially foreign stocks might beg to disagree, a key MTI technical measure suggests this decade’s stock-market ride has been almost entirely “pain free.”

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We’ve never understood investment quants’ desire to project correlations among assets. Such correlations are inherently unstable.

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While the number of recession forecasts is on the rise, there’s a general reluctance among economists to project a downturn in the absence of a yield curve inversion.

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During a stock market rally we find difficult to comprehend, it somehow seems appropriate to publish a chart we’re almost at a loss to explain. The first chart shows the 90-year history of the trailing one-year (252-day) correlation of daily returns across market sectors. Correlations have been in a free-fall of late, and now appear to have a good shot at undercutting the all-time low established midway through the 2000-2002 bear market.

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In mid-summer we suggested that attaining new market highs would probably require a rotation away from the long-time Low Volatility market leaders and into High Beta areas like Technology and industrial cyclicals.

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The correction failed to meaningfully “reset” any long-term valuation measures, hence, we don’t view the current environment as having much investment merit, but rather, primarily speculative appeal.

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We’d rather eat broken glass than have to forecast financial market correlations, but that doesn’t mean we ignore them altogether.

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While our tongue-in-cheek “Correlation Of Everything” measure has retreated from record levels, it remains far above anything seen prior to 2010.

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The decrease in correlations has been helpful for investors, but the lack of volatility in the measure has arguably been more important.

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There are some substantial deviations in sector performance depending on your constituents and weighting scheme while, simultaneously, betas are converging toward one another.

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The recent upside breakout in the U.S. 10-year yield was successful, and it appears interest rates will remain in the new higher range for now. But what are the short-term implications of higher U.S. Treasury rates on asset allocation decisions?

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Value factor performance took off at the end of June last year and never looked back; posting positive Q1 minus Q5 spreads every month since.

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The primary benefits are their inflation and U.S. dollar hedging capabilities.

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A review of correlations and factor performance. Plus, weighting matters in sector performance as we compare the S&P 500 to our Leuthold 3000 universe.

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Correlations have been extremely elevated over the past few years when compared to historical levels. The question is, which parts of the market has this impacted the most?

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As global capital markets are yet again dominated by extreme macro-economic uncertainty, gold appears to be behaving as a hedge against extreme equity market movements, a store of value and an alternative to fiat currencies.

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