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There’s correlation and then there’s correlation

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Well, it is Saturday night and another exciting evening reading my Journal of Financial Planning.  This month there is an article about the correlations between different asset classes, an important topic in portfolio management. The article is talking about how it is important not just to look at the average correlation but look at how consistent the correlation is.  As we have noted, diversification works nicely on the way up but somehow everything goes down during crisis mode – which is kinda when you want it to work.

Basically, global bonds and cash are really uncorrelated with everything else.  Natural resources do fairly well and long-short strategies work okay, except against value stocks.  (Could that be because long-short is almost always long the value stocks and short the growth ones?) Everything else is not really very reliable as diversifiers.

Topics: Investments | 1 Comment »

One Response to “There’s correlation and then there’s correlation”

  1. fred gordon Says:
    September 29th, 2007 at 6:19 am

    E: i read your recent entries. i agree with most of what you assert. the issue of correlation and MPT is a topic i know very little about from a theoretical basis. i do know something about it from an experiential basis. historical correlations in the market work until they dont which means too many people doing the same thing at the same time and all thinking they are hedged. the Crash of 1987 was all about portfolio insurance and its ability or inability to protect you in a down market. this rally in september has been astonishing to me. we will see what the fourth qtr brings. in this recent qtr both commodites and US Treasurys had huge rallies. historically they moved in opposition. BRIC is trumping all of this say the commodity bulls. if we really have a slowdown in US from housing fallout, i dont see how industrial commodities will go higher. gold is simply reacting to weak $. oil at $80 is also completely unsustainable but oil market completely dominated by hedge fund speculation and Opec nations’ games so who knows when it will decline. wall street convinced that oil will trade at $100. i doubt it but if it does, it will haste our recession for sure. all markets now completely driven my Mo investing. as a trader before there were computers, i learned to sell strength and buy weakness. that is completely antiquated in todays’ market. however, the break we had in august is a portent of what happens when Mo investing stops working. f

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