Sunday, May 15, 2011

World Stock Markets are Highly Correlated, but not in Japan

After the stock market crash, instead of hiding my statements in a drawer, I put them on a spreadsheet and stared at them. Maybe that was masochistic. 
Staring did not help much, so I decided to put the stock indexes there too. Now I had something to compare to. does that really well, but I did not know about it at the time. I also wanted to see the different countries. 

What I learned was that my statements followed the indexes, and the indexes followed each other. Now I just watch the indexes, and save the extra work.

In 2009, I put up a post showing that all the indexes were correlated.  Everything was correlated at 0.9 to 0.97. This is a problem, and I'll post on why later this week. 

Time has past, and now we see some indexes tracking differently. This should NOT be surprising, because all these different economies should be different. Anyway, now we see Japan tracking worse than everywhere else.  Why, well it dropped 10% after the tsunami in March. It was already behind, but now it is way behind. Germany is best. China in the middle. 

January 1, 2010 is the zero point. These are percent changes of the various indexes since then. 

Below is the correlation matrix for the different indexes.  Numbers close to one are most correlated, and smaller numbers have the most diversification. The red numbers representing the Japanese Nikkei index are the only ones with much diversification; the Chinese Hang Sang is second, but 0.87 is still pretty correlated. 
Correlation matrix on the above stock indexes. Sorry for having 6 to 9 decimal figures.

Significance - During the crash and the climb-out, money kept flowing around the world equalizing returns. Finance had became a big statistical game, and most of the investments were short-term bets place by computerized arbitrage systems. (See my post on high frequency trading.) That still may be true, but at least we are seeing some difference, and maybe the fundamental soundness of economies can enter in to their valuation. A welcome return of investing over trading.