The Global Stock Market Selloff and the Challenge of Finding Negative Correlations

Over the past few weeks, there has been a global selloff in stocks, with correlations swinging broadly positive [60e6f66c]. This is unusual because there is no single safe haven country, making it challenging to find stocks with negative correlation [60e6f66c]. Correlations help us understand the relationship between different sectors or assets and can help construct portfolios that maximize returns while minimizing risk [60e6f66c]. In the past, it was easier to find stocks with negative correlation, but it is now very difficult [60e6f66c].

The author of the article, Dave Coker, compares the results using Exchange Traded Funds (ETFs) and notes that using a Bloomberg terminal would be unfair as it is expensive [60e6f66c]. He also mentions that the Dow Jones Industrial Average (INDU) and MSCI Emerging Markets (EEM) swung barely positive for one week [60e6f66c]. Dave Coker is a retired investment banker and currently a university lecturer in London [60e6f66c].

Adding international stock exposure is one of the first steps toward a diversified portfolio. However, adding non-US equities has detracted from the returns of a US-only portfolio. Foreign stocks’ correlation with the US market has also increased over the past three years [f7ae1ce3]. Investing in non-US equities provides exposure to sectors that are underrepresented in total US market indexes. Developing-markets equities have demonstrated a lower correlation with the US market than the developed markets’ correlation [f7ae1ce3]. Non-US stocks held up better than US stocks in 2022 amid a bear market induced by the Federal Reserve’s aggressive campaign of interest-rate hikes. But that was a modest victory, and short-lived. As mega-cap US technology stocks led the market again in 2023, non-US stock indexes failed to keep up. The Morningstar Global Markets ex-US Index gained about 16% in 2023, compared with a 26% return for its US counterpart. The Morningstar Emerging Markets Index gained 12% in 2023 versus an 18% gain for the Morningstar Developed Markets ex-US Index [f7ae1ce3]. Most international-stock benchmarks, especially those in developed markets, have been closely tied to the US market over the past three years. Developed-markets equities, especially European stocks, have had the tightest correlation with US equities. Emerging-markets stocks have tended to have lower correlations with US stocks, and those correlations have generally trended down since 2000. The small subset of European stocks from markets classified as emerging have had the lowest correlation with the US market over the past three years. Longer-term correlations also demonstrate that emerging markets generally have a lower correlation with US stocks than developed markets do [f7ae1ce3]. Investors seeking diversification may want to make sure their foreign-stock allocation includes at least some exposure to less-developed markets. Non-US indexes feature a heavier emphasis on traditional value sectors, including energy, basic materials, and financials [f7ae1ce3] [90f60aae].

However, it is worth noting that investing in U.S. stocks can also provide international exposure due to the presence of multinational corporations that conduct business abroad. About 41% of revenue generated by S&P 500 companies comes from international markets [d54ec6d9]. Additionally, the U.S. stock market represents about 60% of the value of the entire world stock market, highlighting its exceptional performance [d54ec6d9]. The success of the U.S. stock market can be attributed to factors such as innovation, business-friendly regulation, and strong corporate governance practices [d54ec6d9]. Therefore, investing in U.S. stocks already provides broad diversification across businesses and industries worldwide [d54ec6d9].

In conclusion, while there are challenges in finding negative correlations in the current global stock market selloff, adding international stock exposure, whether through non-U.S. equities or U.S. stocks, can contribute to a diversified portfolio and provide exposure to sectors that may be underrepresented in the U.S. market. It is important for investors to consider their investment goals, risk tolerance, and the correlation of different markets when making investment decisions.