Correlation Ticking Higher in Current Market Environment

We recently calculated the correlations between the S&P 500, its ten sectors, gold, oil and the 10-year Treasury note over two different time periods.  The first matrix below (click to enlarge) highlights the correlations (between daily % changes) from July 2007 to now.  The second matrix highlights the correlations over the last 10 years, and the third matrix compares the difference between the two sets of correlations.  In the third matrix, numbers highlighted in green indicate an increase in correlation, while numbers highlighted in red indicate a decrease in correlation (or more negative correlation). 

Since July, the market has had a change in personality from cool, calm and collected, to volatile, crabby and downright bipolar.  Based on our correlation matrix, it's easy to see that sectors and asset classes (with the exception of Treasuries) have become much more correlated.  All sectors have become more correlated with each other and the S&P 500 as a whole.  Most have become more correlated with gold and oil as well.  This new environment has put an even greater emphasis on macro-level investment strategies, because diversification is not really providing much diversification right now.

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Comments

[John Forman]

These figures confirm the basic idea that in bear markets everything becomes correlated because market participants end up selling all of it. Traders facing margin calls are end up forced to sell-off "quality" things, and others just throw up their hands and dump everything.