In this entry, we look at the current correlations among global asset classes. The table below shows correlations over the past year (through mid-February), on a worldwide basis. We use daily data, then smooth it to avoid “landing on” a hiccup (more on that in a future post).

The purpose is to better understand the relationships among major asset categories, by quantifying the extent to which they have moved in tandem (or not) recently. Of course, we analyze the relationships among category returns.

So, 1.5 billion calculations later…

The relatively high correlation between global real estate and equities suggests what market observers and catatonics already know: stocks are down in part due to the bursting of the property-fueled credit bubble. (The table does not by itself indicate that either the real estate and equity markets outside the U.S. are either weak or strong; but we know by observation that stock prices in most of the world have been flat to down over the past year, and can read into the broader effects of both the credit crunch and weak U.S. equities accordingly.)

The fact that bond yields are declining faster here than in the rest of the world is a function of property-on-credit weakness and also reflected in the data (which shows bond prices, not yields), as is the negative relationship between our declining dollar and bond prices.

That correlation — between global currencies and bonds — is somewhat more deeply negative than we would have expected, given the almost perfectly unique weakness of the dollar. But we do see the relative strength of most foreign currencies in that category’s negative relationship with real estate, and remind ourselves that ρ is just not very intuitive — that’s one reason to do these analyses, and why leveraged pair-trading strategies can be so attractive. Correlation can range dramatically over time, based on factors such as the lengths of the holding and look-back periods. (We will post “correlation maps” shortly, so that you can see how these relationships take shape, persist or reverse trend, and normalize over time.)

The bills-to-bonds relationship underscores that many recent U.S. homebuyers are getting hammered in ways they may not even realize; and with potential consequences for U.S. trade that have not been widely contemplated, in our view. However long it takes the domestic real estate market to recover (years), how long will it be before the value of the dollar normalizes against a basket of foreign currencies? Again, the answer has to be measured in long years. That both of these highly uncommon and profoundly negative trends are enforcing one another has to be the primary macroeconomic concern of the moment and for the foreseeable future, in our view.

This relationship is uniquely observable in global, cross-category correlations. It’s not just about lowering interest rates to ameliorate a situation brought on by falling home prices. At some point, a country’s inability to trade to its relative advantage hampers economic growth in a way that looser credit makes worse, not better.

The bursting of the credit bubble may cast a longer, darker shadow even than the tech-and-telecom bubble of 2000, which we described in an earlier post as a precursor to and partial cause of the current, slow-motion property crash. And a quick, global recession may actually be less painful for U.S. investors than a purely domestic banana, not that there’s a choice. ♦