It has been a relatively quiet week, but it is highly probable that this calmness will be broken soon. The numerous central bank meetings, starting with the Fed gathering on Wednesday afternoon, and the busy data calendar promise an eventful period. Market correlations are used extensively by market participants to depict the current state of the market. Do long-term correlations stand or has something changed in the market recently?

By using daily data, we calculated the latest 3-month daily correlation, the 3-month correlation ending three months ago, and the 5-year correlation up to six months ago. We have split the examined data in these three periods to get a clearer view of the changes in the correlations from the long-term to the shorter-term.

Correlation is a commonly used metric by investors and traders. When holding a portfolio of assets, either for long-term purposes or for short-term positioning, it is crucial to understand the links between the assets held. A positive correlation means that asset values, and hence profits, move in the same direction at the same time. This looks appealing when the market favours the positions held by investor/traders, but it is extremely damaging when the market goes against the portfolio investments. Hence, market participants looking for a diversified portfolio should take into consideration the underlying correlations of the assets held and aim to reduce their overall risk.

S&P 500 vs. other stock indices

We have calculated the correlation of the S&P 500 with five stock indices, from both the developed and emerging markets. As widely expected, there is a strong correlation historically among the S&P 500 and the key stock indices globally. However, the last 3-month figures show a weaker link among S&P 500 and Nikkei 225, possibly reflecting the resilience by the Japanese stock index during the fourth-quarter slump by US technology stocks. The Hang Seng index is interesting as well as the 5-year correlation appears to be negative potentially due to idiosyncratic reasons driving the Asian index’s performance. More recently the linkage has turned positive, potentially reflecting the improvement in business sentiment in Hong Kong.

More strikingly, the recent emerging market correlations appear much weaker than expected. The positive link between S&P 500 and the Indian Nifty 50 index has declined while the Brazilian stock market currently appears to be unaffected by S&P 500 moves lately. This lack of positive correlation could reflect local factors, particularly the market discounting the outcome of the presidential election.

S&P 500 vs. major FX pairs

The long-term correlation of the S&P 500 against euro/dollar is close to zero as seen in Chart 2 below. However, there have been fluctuations lately and the last 3-month daily correlation appears to be positive. This condition could be explained by the divergent monetary policy outlook in the US versus the euro area. A more hawkish stance tends to boost the US dollar, but with the Fed funds rate almost at 5% there are concerns among stock market participants about both the growth outlook and liquidity conditions going forward. This negative S&P 500-dollar correlation is also evident at the other major pairs, but the most interesting case is the dollar/yen pair. The long-term correlation between S&P 500 and dollar/yen has been calculated to be mildly positive, but over the past 6 months the link has turned negative as the yen managed to record gains against the dollar.

S&P 500 vs. commodities and bitcoin

We also calculated the daily correlations between the S&P 500 index, the main commodities and bitcoin for the specified timeframes. As seen at chart 3 below, there is a long positive link across the board. However, these correlations appear to have weakened lately. Particularly, in the case of oil, the 3-month correlation is now slightly negative, potentially revealing the fear by the stock market for any further oil spikes. Such an event could threaten the current economic momentum and possibly result in a stronger reaction from the Fed.

To sum up, correlations between the S&P 500 and other key stock indices remain positive, but they have weakened somewhat lately versus the historical averages. Interestingly, the historically low correlation of S&P 500 and euro/dollar has moved to positive territory lately. Generally, our findings reveal a negative link between the S&P 500 and the dollar. Finally, the commodities space, including Bitcoin, continues to enjoy a positive link with S&P 500. Only Oil registers a negative 3-month correlation reflecting the market’s angst regarding this key energy commodity's impact on the global economy.