The extreme in finance and economics is by definition rare, and that makes it valuable for study.
The crisis of late is no exception. It’s one thing to analyze markets when everything is running smoothly, but sunny days don’t offer much, if any insight about what to expect during hurricanes.
On the matter of diversification benefits, or lack thereof, one might wonder how the volatility and selling have impacted correlations among the major asset classes. With that in mind, we ran the numbers for trailing 36-month correlations through September 30, 2008, which delivers the chart below.
As usual, correlations are a mixed bag, at least as we calculate them. (Our definition of correlations here is based on the trailing 36 months of monthly total returns. In all cases above, the correlations are in relation to U.S. stocks, as defined by the Russell 3000. The assumption is that investors are looking for opportunities to diversify their equity holdings, which tends to be the dominant risk asset.)
Unsurprisingly, stocks the world over have moved in tighter lockstep recently. In financial panics, all equities look the same, which is to say that investors want now, today, this minute. No wonder, then, that correlations have gone up from already high levels between U.S. stocks (Russell 3000) and stocks in mature foreign markets (MSCI EAFE) and emerging markets (MSCI EM).