ETFs continue to find their way into countless portfolios as investors of all styles have embraced these innovative tools for executing long-term strategies. Although the diversification benefits offered through the exchange-traded product structure are extremely valuable, many investors often times overlook the fact that even the most diversified portfolio is susceptible to rampant volatility. The integration of global financial markets has undeniably sparked a rise in cross-asset correlation levels, prompting many to seek out alternative sources of return that stand to offer refuge whenever the winds all blow in one direction [see also How To Pick The Right ETF Every Time].
During our recent economic downturn many investors took advantage of storing their funds in overseas markets that boasted more favorable growth rates. But with many other developed and even some emerging markets now turning down as well, this practice of leaving the U.S. for greener grass has come into question. As economic regions grow more interconnected, how different is an investment in a European or Asian market when these countries now rely so heavily on each other? Amid the largely uncertain global economic landscape, increasing cross-asset correlation levels add to the risks associated with dipping your toes in the financial markets [see Ex-U.S. ETFdb Portfolio].
The S&P 500 Index is often times used a gauge for the entire U.S. market, and as such, the correlation matrix below highlights the relationship between this popular domestic benchmark with the rest of the world over the past 6 month, 1 year, and 2 year periods. At first glance, it’s quite obvious that over the short-term, each of these countries maintain a high level of correlation among each other; however, some noteworthy differences become apparent when you expand the investment horizon [returns as of 11/9/2012 using AssetCorrelation.com].
Some Surprising Standouts
Spain and Italy both have low correlation to the U.S. when looking at the 2-year column, which is more than likely attributable to the region’s debt crisis which remains largely unresolved. Switzerland also seems to drift away as well, but as a euro free economy that prides its currency on being a safe haven, many might expect for this nation to have an even lower correlation with U.S. markets. The biggest surprises are emerging markets Brazil and Mexico; seeing as how both of these countries rely heavily on trade with the U.S., especially Mexico, it’s quite surprising to see that they have managed to post low levels of correlation with the U.S. market over the trailing 2-year period [try our Free ETF Country Exposure Tool].
More of the Same
Not surprisingly, Australia, Germany, Japan, and the UK have the highest correlation to the US over the past two years. These developed markets have strong ties to the U.S., which has proven to be a good and bad thing depending on how we preform. Many emerging markets such as Turkey, Singapore, China, and South Africa have a lower correlation to the U.S. in the short term, but over time investments in these countries seem to mirror the U.S. This correlation table casts some light on just how connected the global economy is, but for investors looking to diversify luckily there are many country ETFs that specialize within markets, offering niche views of the world [try our Free ETF Screener].
Disclosure: No positions at time of writing.