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Euro and S&P 50: Don't Be Fooled by the Optics
It is commonplace now to talk about break down of the risk-on/risk-off (RoRo) matrix and in particular the decoupling of the euro from the S&P 500. Be careful. Most observers were slow to recognize this decoupling, which we had been writing about for some time, and are missing the more recent trend in which the linkage has tightened.
Our methodological point is that it is difficult to accurately eyeball correlation. Correlation is a statistical relationship. Many observers see the euro off 2.7% against the dollar this year and recognize that the S&P 500 is up 8% and see this as a sign of a weak correlation.
Look at the data though, and a different picture emerges. As investors, we are most interested in the correlation of returns. To gauge this we look at the correlation of the percent change in the euro and the percent change in the S&P 500.
Over the past 60-days the correlation stands at 0.44. This is well above the low set in early February near 0.25, which was the lowest correlation since March 2011. The 60-day correlation finished 2012 near 0.41.
Moreover, the 30-day correlation is substantially higher near 0.68. It bottomed in early Jan below 0.1, the lowest in a year. The current reading is just below the last peak in Oct 2012 near 0.70. That the 30-day is so much higher than the 60-day correlation indicates that the relationship between the euro and the S&P 500 is much tighter currently than those simply looking at the charts can appreciate.
When running correlations between the euro an interest rate or spread, we find that conducting the study on percentage change is often misleading (percentage change of a percent) and opt to look at levels or values. We continue to point out how well the US-German 2yr interest rate spread tracks the euro-dollar exchange rate. The 60-day correlation is at 0.75, at the stronger end of where it has been over the past several years. The 30--day correlation is about 0.93.
The other relationship that investors are presently sensitive to is that between the euro and Italian debt. The euro and the Italy's 2-year yields are inversely correlated (-0.55). At the end of January, that is, before the Italian election, the inverse relationship was even greater at -0.85.
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Orly--my work would show that the correlation between S&P and euro-yen was mostly inverse until the crisis and has been positive since early 2007. However it has been making lower highs. It is now near 0.45, having fallen to near 0.25 on Feb 11.
Your other question was about interest rates. I still show the dollar against the yen is more correlated to the 10-year spread than 0.92 than the 2-year 0.75 over the last three months. In the same period last year, the 2-year was more correlated to dollar-yen movement. As this illustrates, in the time frame most of us operate, the correlations can and do move around quite a bit and I find it helpful to be generally aware of where they are.
Hope this helps.
Great, yeah. Thanks.
Where does a lay-person without access to a Bloomberg terminal or a dedicated data feed find information on bond spreads? I have looked on the 'net and the information is very limited.
:D
Here is one for 10 year spreads http://www.bloomberg.com/markets/rates-bonds/
two year for Spain http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=ES%3A2YR...
Italy http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=ES%3A2YR...
Germany http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=IT%3A2YR...
Muchas gracias!
In 2008, the S&P had started declining even before the Euro started plummeting.
In the RoRo environment, the EURJPY correlation to SPX was even greater, wasn't it? It seems that this correlation has broken down as well.
Or was that correlation more dependent on US 10-year yields, as the USDJPY is? Do you see yields coming off enough to cause a correction in the USDJPY and yen crosses?
:D