Given yesterday’s monster $66B Trade Deficit (see chart below), perhaps its time to look at some other factors that might be influencing both US and Foreign Markets.

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Many people’s working assumption has been that markets outside the US were closely correlated to the US dollar. Indeed, up until the autumn of 1999, equity markets outside the U.S. loosely tracked moves in the dollar.

Since then, however, they have diverged from the buck, and instead tended to mirror the performance of the S&P 500.

Why?

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Changing Influences on Foreign Markets
click for larger chart
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This raises several questions, but the one that leaps to my mind first is if overseas markets are tracking the S&P500, then why should investors bother diversifying overseas? There are plenty of other good reasons to do so, but uncorrelated returns to US markets may no longer be one of them.

Michael Panzner notes that it comes down to several factors in no particular order:

1) more U.S. players (hedge funds, broker-dealers) are "exporting" the arbitrage and investment strategies that use in the domestic market to other parts of the world;

2) the growth of the internet and of 24/7 business/financial news coverage, especially over the past five years, means investors all over the world are immediately aware of new developments and market trends occurring elsewhere;

3) the heavier-weighted (i.e., largest cap) stocks in most mature markets tend to be multinationals (think Sony, BP, Deutsche Bank, HSBC, etc.) which trade more in line with each other than with domestic peers, sectors, or indices;

4) expanding global trade has caused some degree of convergence among many leading economies, as well as supply-and-demand patterns for goods such as oil;

5) correlations tend to increase in bear markets (of course, the market has been rallying since 2003, but sentiment-wise, one could argue that what we have now is unlike the bullish euphoria we saw in the last half of the 1990s).

I am sure there are more, but you get the idea.

Category: Currency, Markets

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One Response to “Changing Influences on Foreign Markets?”

  1. John Bott says:

    I think it stands to reason that as cross border trade increases and becomes more & more efficient (via trade agreements, etc), R between developed markets and the SPX will get closer and closer to 1. Investors will need to start owning more emerging market stocks in order to seek lower R.
    Clearly, the main caveat is the potential for increased protectionism, which would cause R between developed nations and the SPX to fall again.