As the bond market has been skyrocketing since November of last year, we have seen some weird “correlations” between the stock market and the bond market.
You see, many expect a bond market rally to correlate with a stock market decline. In fact, when I suggested that the bond market was going to rally strongly into the spring of 2019, I would see many comments similar to this one:
“In essence, you’re doubling down on your stock market correction/recession call”
So, I explained to that commenter that we analyze each chart on their own and my call on the TLT was only based upon what I see in the TLT chart. Unfortunately, too many people try to correlate one chart to another, and it often leads to very poor trades.
To start, you must understand that each market has its own sentiment to track. Sometimes, the sentiment pattern in one market is trading in unison or even inversely to a sentiment pattern in another market. This is what people view as “correlations.” But, I want to highlight the fact that a correlation is simply when two charts are trading in relative unison or inversely for a period of time.
But, when one chart – which could be in a more mature pattern than the other – completes its pattern and reverses, and the other still has further to run before it completes its pattern, the person relying on that “correlation” will be left scratching their head.
Yet, if you are able to analyze each chart on its own, then you would have early warning of impending changes in supposed correlations. But, then again, if you are able to analyze each chart on its own appropriately, and can even pinpoint when these supposed correlations will break down, you would not need to even worry about correlations to begin with. For this reason, I have no need to, nor do I ever, rely upon correlations.
Allow me to tell you a little story.
In 2015, I started to warn the members of The Elliottwavetrader.net that I see many commonly followed correlations setting up to break down. Based upon my analysis of the individual charts and markets, it was clear that the correlative charts upon which investors have relied for many years were setting up to break those correlations. I then reiterated this perspective in early 2016 when I wrote the following article for Gold Eagle:
And, not long thereafter, many correlations began to break down, with Morgan Stanley publishing this chart showing what I was expecting to happen:
They further noted:
Morgan Stanley's Andrew Sheets summarizes the stunning move as follows: "Regional correlations, cross-asset correlations and individual stock and FX correlations have fallen simultaneously. That's unusual; we haven't seen a shift this severe in over a decade" and ultimately calls it for what it is: a "crash" in correlations unlike any seen before.
So, when I was asked about what my expected TLT rally meant to other markets, my answer was simply that my TLT analysis provides only a forecast as to what I expect in TLT.
I sincerely hope that my article provided a bit more clarity as to what these supposed correlations really represent. And, for anyone that places money at work in reliance on correlations, I implore you to gain a better understanding of the underlying markets that you are attempting to correlate. For if you are unable to identify an impending change in the correlation, then relying on that correlation may eventually lead to more losses than the gains you make in relying on such correlation.