Goldman: “The Last Time Correlations Were This Low Was Just Before The Financial Crisis”
In a note from Goldman’s cross-asset strategist Ian Wright, the bank points out something troubling: on one hand, over the past six months, or rather since the US elections, equity markets around the globe have soared, and returns across regions have been “strong” – S&P 500, Stoxx 600, Nikkei 225 and MSCI EM ($) have returned roughly 11%, 16%, 20% and 11% in local currency price terms, respectively, with MSCI World ($) up 12% over the same period. In other words, everything is up. And yet, while equity indices have rallied across regions, inter-regional equity return correlations have actually fallen materially to their lowest levels since 2000.
Why is this troubling? Because as Wright casually throws out, “the last time correlations were this low was in 2007, just preceding the financial crisis”
So does this imply that a financial crisis is imminent? Goldman isn’t sure, and notes that the collapse in correlations “leads to the questions whether we expect correlations to remain low or whether we expect equity markets to recouple and move more in lock step, and what the environment will be from here. In our asset allocation, we are overweight Asian and European equities and underweight US equities over both 3- and 12-month views, with the former on growth expectations inflecting and an earlier cyclical position supporting EM and EAFE while, in the latter, the expectation that higher valuations and the later cycle of the US weigh on returns (see Exhibit 2 for return forecasts).
And just to hedge its bets, and not upset too many clients, Goldman even provides a bullish spin on the data: As Wright adds, “Exhibit 9 shows that while inter-regional equity correlations have indeed come down on average, they have remained more elevated between non-US markets such as Europe and Japan. We would not be surprised to see this trend continue in the absence of growth shocks and with anchored volatility, with the US the lagging performer from here. Data based on May 5, 2017 market close.”
Which will be right outcome: collapsing volatility as a precursor to another crash, or a catalyst for even more gains? Look to this week’s barrage of Fed speakers for the (rhetorical) answer.