When investors are freaked out, they’ll dump stocks, bonds, and other investments simultaneously and almost indiscriminately.
During periods of crisis, numerous asset classes will make big swings hand in hand. In other words cross-asset correlations rise. And in the wake of the financial crisis, correlations surged.
One of the downsides of rising correlations is that investors and money managers lose their ability to diversify their portfolios.
However, those correlations have come down sharply in recent months.
“2013 has been a year marked by a fall in correlation between asset classes, countries, factors and stocks,” wrote Nomura’s Sarah McCarthy, Rupal Agarwal and Inigo Fraser Jenkins. “That is a natural response as the nadir of the crisis recedes further into the past and normality returns to markets that can respond to their own ‘fundamentals’ rather than one common risk-on-risk-off dynamic. That means that asset markets can start to diverge.”
“Absolute correlation among asset classes continues to fall rapidly (Fig. 41), showing a smaller magnitude of co-movement between asset classes, indicative of a normalisation,” they added.