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Correlations Profile | Major Asset Classes | 23 January 2020

Summary:
Return correlations for the major asset classes have edged down in recent years, which implies that diversification opportunities have increased, if only marginally. The correlation readings are only modestly softer overall and for several asset class pairings it’s fair to say that nothing much has changed. But reviewing all the key slices of global markets by way of pairwise return correlations shows that the median for this risk metric has slipped, based on a set of proxy ETFs. The median correlation for the major asset classes was 0.34 at yesterday’s close (Jan. 22), based on daily returns for the current one-year rolling period (252 trading days). That’s close to the previous low of 0.30 that was reached in the early weeks of 2018. Despite the latest downtick, the median

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Return correlations for the major asset classes have edged down in recent years, which implies that diversification opportunities have increased, if only marginally. The correlation readings are only modestly softer overall and for several asset class pairings it’s fair to say that nothing much has changed. But reviewing all the key slices of global markets by way of pairwise return correlations shows that the median for this risk metric has slipped, based on a set of proxy ETFs.

The median correlation for the major asset classes was 0.34 at yesterday’s close (Jan. 22), based on daily returns for the current one-year rolling period (252 trading days). That’s close to the previous low of 0.30 that was reached in the early weeks of 2018. Despite the latest downtick, the median correlation is still well above the low for the past decade: 0.19 in early 2015. (Note: correlation readings range from -1.0 (perfect negative correlation) to zero (no correlation) to +1.0 (perfect positive correlation.))

Correlations Profile | Major Asset Classes | 23 January 2020

Let’s drill down into the data and focus on a select group of return pairings via the correlations between the US stock market and foreign equities in developed, emerging markets and also vs. US bonds. On this front, two distinct trends are clear. First, the correlations between US and foreign stocks have remained relatively high and mostly stable, based on Vanguard Total US Stock Market (VTI) vs. Vanguard FTSE Developed Markets (VEA) and VTI vs. Vanguard FTSE Emerging Markets (VWO). For US equities vs. US bonds — based on Vanguard Total Bond Market (BND) – the correlation has been drifting deeper into negative terrain over the past year and is currently at -0.35, close to the lowest print in recent years (green line in chart below).

Correlations Profile | Major Asset Classes | 23 January 2020

For a broader review of correlations, let’s look at the complete data set for all the major asset classes, based on the following fund proxies:

Correlations Profile | Major Asset Classes | 23 January 2020

Using the ETFs above for analysis shows that most of the correlation pairings for daily returns over the past year are positive in varying degrees, although there are several pockets of mildly negative results. The deepest negative correlation is currently between US stocks (VTI) and US bonds (BND) at -0.35. Keep in mind that even positive correlations can provide significant diversification benefits for portfolio design, particularly for pairings below 0.80. Note, too, that the lowest correlations are posting a modestly deeper shade of red compared with the Oct. 2018 profile.

Correlations Profile | Major Asset Classes | 23 January 2020

For another perspective, the next table below maps all the pairwise correlations for daily returns on the basis of the current five-year trailing window. Using this longer time frame shows that correlations can be lower in some cases vs. the one-year period review. That’s a reminder that the diversification possibilities for portfolio design may be more robust at longer-term horizons.

Correlations Profile | Major Asset Classes | 23 January 2020

Finally, here’s another perspective based on rolling one-year returns (252 trading days) to calculate correlations for the trailing five-year period through yesterday. Analyzing correlations via this time period suggests that substantial diversification opportunities exist for building a multi-asset class portfolio that’s held through time.

Correlations Profile | Major Asset Classes | 23 January 2020


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By James Picerno


James Picerno
James Picerno is a financial journalist who has been writing about finance and investment theory for more than twenty years. He writes for trade magazines read by financial professionals and financial advisers. Over the years, he’s written for the Wall Street Journal, Barron’s, Bloomberg Markets, Mutual Funds, Modern Maturity, Investment Advisor, Reuters, and his popular finance blog, The CapitalSpectator.

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