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Commodities And Yields Recoupling With Stocks

By Michael HarrisMarket OverviewFeb 23, 2014 05:40AM ET
Commodities And Yields Recoupling With Stocks
By Michael Harris   |  Feb 23, 2014 05:40AM ET
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The coupling of commodities and yields with stocks ended in the middle of last year but created problems for funds that persisted in betting on such correlations for longer. Commodities started to recouple with the stock market in the third quarter of last year and yields followed last month. Is the new recoupling a sign of a replay of the 2012 good times in the stock market or the result of wishful investor thinking? Does this matter anyway?

SPY Daily
SPY Daily

On the above daily chart, the middle pane shows the rolling 60-day correlation of daily arithmetic returns of the SPDR S&P 500 ETF, (SPY) with the iShares Barclays 20 Year Treasury Bond ETF, (TLT) and the bottom pane of SPY with the PowerShares DB Commodity Index, (DBC). The vertical blue line is set two years ago, on February 21, 2012, and the values of the correlations for that date appear at the upper left corner of each pane. The values of the correlations as of the close of last Friday are shown on the right axis of each pane in black background.

The recent recoupling of stocks with yields and commodities has brought their correlations about half-way where they were two years ago. Still the correlations have a long way to go to reach 2012 levels. The question that arises here is whether these correlations are structural or a result of investor wishful thinking, i.e. the result of an ill-perception of many investors and fund managers that this market has still a long way to go and that yields will also fall, therefore there will be gains in both stocks and bonds. (Recall that when yields fall, bond prices gain). At the same time, due to their financialization via ETFs, commodities follow along.

Or is this maybe some type of a 50% - 61.8% Fibo retracement of the correlations and then we will see them close to neutral again? Note that the market need not correct to have neutral correlations as one scenario is a rise in stocks and a fall in bond prices. Of course, the other scenario is a stock market correction along with a rise in yields, something that can happen if rates rise, for example.

The key to the future course of the market is, like always, inflation and interest rates. If inflation remains low and interest rates are low, then the stock market will go higher and bonds may follow along. Otherwise, stocks will correct and bond yields will rise. But markets cannot stay high for long because of investor wishful thinking because reality is bigger than anyone's wishes; no matter how big is his portfolio.

Disclosure: no relevant positions.

Commodities And Yields Recoupling With Stocks

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