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Tag: Correlation

A shift away from RORO? – Sober Look

Something strange happened in the market today. The dollar (DXY) and the US equity indices traded lower – together.

Source: MarketWatch

Historically one would indeed expect a positive correlation between these markets. After all, a healthier US economy – at least in principle – should benefit both the US dollar and the stock market. And the reverse also holds true. But these are not normal times. Since the financial crisis, the correlation has been consistently negative, making today’s move unusual.

Correlation between the dollar (DXY) and the S&P500 (daily returns, rolling 90 day correlation)

That’s because markets switched into the “RORO” (risk on/risk off) mode after the Lehman collapse. And the dollar has clearly been viewed as a “safety asset” – an asset that rallies in a risk-off scenario (see discussion from 2009).

So does today’s bout of positive correlation point to signs of normalization? Only time will tell. But this relationship is important to watch, as it will signal any major regime changes in the market and a potential shift away from RORO.

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Sharp declines in equity correlations should improve alpha generation – Sober Look

The implied correlation futures contract has touched a new low recently. With the Eurozone seemingly stable for now, correlations among US stocks have declined. That means share prices are now driven to a somewhat larger extent by company fundamentals than by macro events in Europe. This is good news for stock pickers who have struggled to outperform the market in recent years (see discussion). Alpha generation by strong portfolio managers should improve.

Source: CBOE

For those interested in learning more about how the implied correlation index is computed please see this paper from the CBOE.

Implied Correlation Indicator
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