Investors who adhere to the recommendation of keeping a diversified portfolio may panic when markets trade in step, and that step is down. But we believe it's better to stay the course, because, like any phenomenon, this one will pass.
The recent high degree of market correlation is the result of the Federal Reserve and other central banks pulling liquidity out of the markets by raising interest rates, says David Blitzer, chairman of the index committee at Standard & Poor's. That makes risk-taking more expensive.
"Markets tumble, people can't ignore oil at $70 forever. This is unfolding as usual when liquidity drains," Blitzer says. "This is a moment when they all move together. It really was no surprise. We were living on borrowed money, there was a lot of speculation, and everybody turned chicken at once."
According to S&P data, all the major world markets moved up together this year through May 9, and have moved down together since.
As a result of coordinated interest rate hikes around the world, the S&P Citigroup World Index has fallen 12% since May 9, with declines seen in both U.S. and international equities. The index posted solid double-digit gains through early May. The strong correlations among various global stock markets has only increased volatility and risk, in our view, as the vast majority of issues move in the same direction on any given day.
Rosanne Pane, a mutual fund strategist with S&P's portfolio services, sees better times ahead. "When markets stabilize, the more attractive opportunities begin to separate from the other market sectors, and you begin to see declining correlations," she says.
S&P advises putting 45% into U.S. stocks, 20% into foreign equities, 20% into short-term bonds, and 15% into cash.