How Correlated Are Stock Markets?

Posted by admin on October 24, 2009 in stock market | Short Link

A recent trip on the Eurostar had me in possession of a copy of The Spectator. It isn’t a magazing that I tend to read more than once per year – it is a little too Central London centric for my tastes…

In it, was an article by Matthew Lynn titled, “We’re all Shanghai gamblers now”.

The article put forward an interesting idea that stock markets around the world – most notably in the US – are becoming more highly correlated with the Shanghai bourse. He quotes a figure of 18 percent correlation between Shanghai and the S&P500 in the last three months. This all sounds impressive, and the picture painted is a worrying one, that our pension funds and savings are being unduly influenced by the gamblers of China.

Perhaps.

In contrast, I can recall an article a few years ago in the Investors Chronicle. The article detailed the level of correlation between the US and European markets. The Swiss stock market was the least correlated at something like 93%!! (I forget the exact number now.)

The reality, I think, is that in a globalised world full of multinational corporations, markets will – and probably should – move together. C’est la vie.

It seems to me that this is a natural result of investment managers, pension funds, governments and corporations all trying to diversify their risks away by being in many sectors and markets simultaneously. After all, if an investor has assets in many countries and something makes him or her sell assets immediately (a margin call perhaps), those sales will likely be from multiple markets. If there are many doing exactly the same, the results are maginified.

Now think along those exact same lines, but multiply the numbers many, many times for a few hundred hedge funds all doing identical things simultaneously… Not pretty is it?

So my question is, “Are we any worse off by being connected to Chinese gamblers than we are by being connected to hedge fund gamblers?”

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