Friday, May 8, 2009

Stock Market Indexes are Highly Correlated

I have graphed several different stock market indexes including the Dow, NASDAQ, DAX, Nikkei, S&P, Wilshire 5000 and the Hang Seng. In case you don't know, these are three indexes from the US, Germany, Japan and China. This includes the time from the crash in October 2008 to today. We see that attempts to diversify geographically have not worked very well. 

Above is the correlation matrix - click on the table to enlarge. Most of these stock index are very much the same.  The correlation between the Wilshire and the S&P is 99.8% --where 100% is perfect. The least correlated pair, the Hang Seng and the Dow, have a correlation of 93.5%. You would think the Chinese market would be more distinct from the biggest US companies. 

This shows the world is a global village.

This is interesting and discouraging because the investment practice of REBALANCING, encourages us to put assets in different places, and then shift money between asset groups to get the best return. See William Bernstein's book The Intelligent Asset Allocator. If these geographic markets track each other so closely, this technique can't work very well.