The trend in the degree to which the world’s stock markets move in sync with each other has fallen to the lowest level in 20 years.
The lower correlation enhances the potential risk-reducing benefits of diversification.
This may be especially good news right now since stocks may be due for a pullback.
Stocks are off to a strong start this year, but the bulls aren’t running in a herd. Bull markets can be found in the stocks of countries around the world, but their movements are less correlated with each other than they have been in the past 20 years. The change brings the return of an important diversification benefit for holders of globally diversified portfolios.
Zigs and Zags
Traditionally, the logic behind including international stocks in a portfolio was not just for their potential returns, but also for the benefit of risk-reducing diversification. The thinking is that when one market would zig, another would zag, resulting in a smoother path to financial goals.
Sadly, for much of the 2000s, global diversification had all but faded away as stocks around the world increasingly moved in sync with each other. In our view, there were a couple of key reasons for this.
- Global stocks were collectively impacted by the U.S.-focused technology and housing bubbles.
- The increasingly integrated global economy boosted international sales to exceed domestic sales for the global companies in the MSCI All Country World Index.
- These factors contributed to higher correlations across stock markets: when one market would zig, the others would zig too.
Return to normal?
Fortunately for investors, diversification has made a comeback. Measured statistically, the trend in correlation between stock markets of the Group of 20 nations (plus Spain, which is a quasi-member), that together make up 80% of world GDP, peaked in 2011 and has since fallen to levels not seen in 20 years, as you can see in the chart below.
Trend in global stock market correlation slides to 20 year lows
Daily one-year rolling correlation of one month percent change in MSCI indexes for countries in G20 and Spain.
Source: Charles Schwab, Macrobond, MSCI data as of 4/12/2019.