Canada Cup of Correlations

Canadian equity returns and global markets.

June 24, 2010

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story_images_Canada-flagIn adverse markets, all equity correlations seem to go to one – and bond-holders make out like bandits. At least until interest rates rise.

Is there a way off this treadmill?  Well, under current market conditions, emerging markets and commodity currency countries – Canada, Australia and New Zealand – have fared reasonably well.

A recent CIBC Economics report tries to put this into perspective. It’s not an unambiguous proposition.

“While the average correlation between Canadian and US stocks has risen somewhat over the past two decades, the more impressive increase in correlation has been against non-US markets where it more than doubled since the early 1990s as demand for Canadian raw materials, particularly in the developing world, took off.” write CIBC economists Benjamin Tal and Meny Grauman. “Canadian equity returns are still less sensitive to global markets than stocks in either Europe or the US, but not by a very wide margin.”

There’s another caveat. When everyone is seeking a safe haven, Canada isn’t the obvious one.

“Digging deeper into the correlation between Canadian and global equities, we find that not only do Canadian stocks increasingly move in sync with stocks on the other side of the globe, but that this relationship tends to increase during periods of increased financial market stress. Canadian equities are almost twice as correlated with global stock moves during months when international markets underperform their long-run average than during periods when stocks are doing well.”

Safe havens during market tumult are more likely to be provided by currencies, CIBC reports. As for bonds:

“Canadian bonds also exhibited a negative correlation with global stocks, but we would tend to be cautious of fixed income in an environment when the Bank of Canada is poised to raise rates.”

It’s a risky environment. But, to paraphrase the 1960s song:  risk grows where rewards go.

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