The Euro and the S&P 500: Correlation Update

(This follows up on posts here and here.) One of the characteristics of the investment climate that we have tracked over the course of the year is the tight relationship between the euro and the S&P 500. The following observations are based correlations conducted on percentage change of the euro and the S&P 500.

The 60-day rolling correlation between the euro and the S&P 500 steadily rose since early March when it was 0.17. The record, going back to the early 1990s, using a synthetic euro, was just recorded on Dec 2 at 0.85. The correlation has barely changed since then. 

However, the 30-day rolling correlation is beginning to weaken, though it is still at historically speaking high levels. The record high was sent in early November near 0.91. It stands just above 0.81 now.

This correlation is one of the key relationships for many global investors. It captures the risk-on/risk-off feature of the global capital markets. The Australian dollar is as correlated with the euro as the euro is with the S&P 500, as broader illustration of the same point.

What could see the correlations fragment and for the S&P 500 to decouple from the euro? After chasing overseas returns, more Americans may keep more of their money at home. The S&P 500 is off as of this writing about 3.4% year-to-date. This makes it easily the best performing market in the G10, and it beat most emerging markets, including the BRICs.

Many global fund managers appear under-weight US equity exposure, perhaps due to under performance. Even though the US economy is still struggling under the weigh of de-leveraged and a depressed housing market, growth next year, even if in the 2.0%-2.5% range, would still likely place it at the upper end, if not the top of the G10.

Anticipating potential triggers of a real break down in the correlation is one thing, the actual break down is different thing altogether. The softening of the 30-day correlation between the euro and S&P 500 should properly be seen as suggestive, but investors may be best advised to be patient and await confirmation.