Market Analysis: August 2008

"With increasing globalization, every asset class is related to every other one. This makes it useful for understanding how these relationships shift over time. Many times, movements in one asset class will anticipate movements in others. With an understanding of how these different groups are moving--stocks, bonds, interest rates, and commodities--we can appreciate the themes that are driving markets that day.

Since 2007, on days when the euro (FXE) has risen versus the U.S. dollar, the average price change in the S&P 500 Index (SPY) has been -.15% (107 occasions up, 112 down). When the U.S. dollar has risen versus the euro, the average price change in the S&P 500 Index has been .14% (112 up, 83 down).

On days in which the euro has risen versus the U.S. dollar, the average price change for commodities (DBC) has been .42% (137 occasions up, 82 down). When the dollar has risen versus the euro, the average price change in commodities has been -.22% (91 up, 104 down).

When the euro has risen versus the dollar, the average price change for oil (USO) has been .59% (130 occasions up, 89 down). When the dollar has risen versus the euro, the average price change in oil has been -.32% (88 up, 107 down).

When short-term Treasury notes (SHY) have risen in price (yields falling), the average change in SPY has been -.42% (83 up, 136 down). When Treasury notes have fallen in price (yields rising), the average price change in SPY has been .44% (136 up, 59 down). When short-term notes have risen in price, USO has averaged a gain of .24% (123 up, 96 down). When short-term notes have fallen, USO has averaged a gain of .07% (105 up, 90 down).

These are not permanent relationships that serve as the basis for mechanical trading. Rather, they are correlations that reflect broad themes such as recession concerns, inflation worries, and the like. By understanding how asset classes are moving--and moving relative to each other--we can gain insight into the mindsets of institutional money managers."

- Brett Steenbarger

Dr. Steenbarger has sum up my entire correlation system in very effective way in his financial blog TraderFeed. Thank You Dr. Steenbarger.