A diversified portfolio is one that consists of uncorrelated assets. In other words, these are assets that don’t move hand-in-hand all of the time. Diversification reduces volatility.
It’s important to recognise that correlations are not static. During periods of panic, correlations increase as investors and traders buy and sell stuff almost indiscriminately. And that’s not the only thing that causes correlations to evolve.
It shows the changing correlation between the S&P 500 and six other asset classes since 1965.
There are a few interesting things to note.
EAFE is MSCI’s index of developed market stocks and EM represents the emerging market stocks. Both have seen correlations approach 1 in recent years. This likely reflects the growing presence of U.S. companies abroad and vice versa.
Gold continues to have a near-zero correlation with the S&P, which means they basically move independant of each other.
The U.S. dollar currently has the most negative correlation with the S&P. A weak dollar makes imports more expensive. However, it also makes U.S. goods more competitive overseas.
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