Watch Out, Correlations Are Rising Again

As if you needed another reason to worry about the health of the economy, markets are now indicating traders are starting to act more herd-like, according to Societe Generale.

That’s worrying because, in the two most recent experiences with financial worry, we’ve seen correlations pick up. In 2008, the rise was related to the financial crisis, and resulted in a prolonged crisis. The second spike was at the height of U.S. double-dip worried and the Greece crisis. It quickly abated.

Now we see correlations rising again, and while they are no where close to the 2008 or 2010 levels yet, it still suggests that market worries are starting to rise, and the risk off, risk on paradigm is taking hold once more. And it’s all about the return of contagion risk from the Greek crisis.

From Societe Generale:

Contagion creates correlation for a number of reasons. Liquidity dries up to a large degree and the remaining flows are often dominated by global risk-on/risk-off type of trades. Relative value investors are pushed to the sidelines, while directional macro calls are causing prices to move in lock step. Chart 7 depicts the rolling 20-month correlation of weekly data for various randomly selected pairs of asset classes. A peak following the financial market crisis, followed by another peak after the start of the European sovereign debt crisis of 2010 are easily recognisable. After a decline in correlations in Q1 2011, it now appears that a renewed incline is materialising.

Note the rise in contagion, across asset classes:


[credit provider=”Societe Generale”]