Friday, August 08, 2008

Tracking Themes Among Asset Classes With Rolling Correlations

One way I like to track themes in financial markets is by tracking rolling correlations. These can be correlations among stock sectors/indexes or between equities and other asset classes.

Here are a few correlations of daily returns since June that caught my eye:

S&P 500 Index (SPY) and rising U.S. Dollar (UUP): .58
Rising U.S. Dollar (UUP) and Commodities (DBC): -.53
S&P 500 Index (SPY) and long-term Treasury bond prices (TLT): -.56

When we've seen a rising dollar and weak commodities, that's been associated with rising stock market prices (which we clearly saw today). When we've seen money pour into Treasury instruments (a common flight to safety trade), that's been associated with falling stock market prices.

As traders and portfolio managers place their bets on global inflation and recession, we can track their views in the movements of these and other instruments and asset classes. These movements can be tracked in the waxing and waning of rolling correlations. More on this theme to come.