When markets are highly correlated, it can be tough to stay diversified. If various markets are moving up or down in unison, your risk and volatility can quickly get out of hand. That’s why we’ve started keeping an eye on two statistics that illustrate how easy or difficult it has been to stay diversified in the futures markets: the risk on/risk off trade, and market correlations.
Risk On, Risk Off
November added two risk on days and two risk off days to the year’s tally, leaving the percentage of each this year essentially unchanged. Two of those four days came on either side of the election (Nov. 6-7), with the risk on markets gaining an average of 1.38% before the results came in, and then promptly shedding -1.49% the day after. Assuming the markets don’t go haywire in December, we’re on track for a final tally in line with the risk on/risk off tallies we witnessed in 2011. (If you need a refresher, we broke down the risk on/risk off trade earlier this year.)
Risk On = average gain of over 1% for “risk” assets; Risk Off = average loss of over -1% for “risk” assets.
As a refresher, correlation is a statistical measure of how interrelated two sets of data are. A correlation of 1.00 would mean that the markets move in lock-step, and a correlation of -1.00 means that they always move in opposite directions. For diversification value, what we’re looking for is non-correlation (a correlation of 0.00), which would mean that the two markets are behaving as though they are completely unrelated.
The overall market correlation in November was higher than it has been in the past few months, coming in at 0.319 (based on the absolute value of all market correlations). Energies were more correlated with stocks and metals than in October, while Treasuries were less negatively correlated with metals and most currencies (though they remained strongly negatively correlated to stocks). As we’ve observed throughout the year, the Japanese Yen and natural gas stood out within their respective market sectors as excellent diversification plays.
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Disclaimer: past performance is not necessarily indicative of future results.
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.
Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.
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