Are Asset Class Correlations At A New Permanently High Plateau?

The coronavirus crisis reordered many things in economics and finance and you can add asset correlations to the list. After markets crashed in March, followed by a strong (so far) rebound, asset classes have continued to move with an unusually deep and broad degree of unison. High, or at least higher return correlations aren’t unusual around periods of severe market corrections. The question is whether it’s different this time in the sense that the jump in correlations endures?

The answer, of course, is unknown for the usual reason: the future is as uncertain as ever. But in the current climate, it’s reasonable to wonder if the standard ebb and flow of correlations that usually prevails has given way to return relationships that remain tightly linked for longer or perhaps even permanently.

This is more than an academic question since higher correlations imply lower benefits from asset-class diversification. In turn, the change translates to higher portfolio risk and incentivizes the search for alternative risk-management techniques to pick up the slack.

The raw material that arguably has contributed to what may be a regime shift for correlations start with the arrival of extraordinarily dovish monetary and fiscal stimulus programs the world over. As The Economist this week observes, “The pandemic has accelerated a rethink of macroeconomics. It is not yet clear where it will lead.”

This change has been brewing for a decade, ever since central banks and governments responded to the 2008-2009 financial crisis. The stimulus never really went away, although it did fade in varying degrees around the world. But when the coronavirus shuttered much of the global economy earlier this year, the focus shifted back to dovish policies and in a degree that’s unprecedented. Given how deep the world has gone down the monetary and fiscal rabbit hole in 2020, it’s unclear how soon, if ever, the global economy will return to “normal.”

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Moon Kil Woong 8 months ago Contributor's comment

If the US goes the way of Japan he answer will be yes. Hopefully, the economy will recover and growth will resume from where it left off pre-pandemic or even pre-Obama and Trump.