A long-time friend in the commodity markets today exclaimed, “Everything has a coefficient of one!” This is a very succinct way of noting that something is fundamentally wrong in the markets today when everything tends to move together. Modern Portfolio Theory is built on the assumption that one can identify productive asset classes that have a low correlation to each other — a correlation coefficient of zero between two assets indicates that the movement of one has nothing to do with the movement of the other. A coefficient of one indicates that the assets move in lock-step with each other. One of the remarkable characteristics of this year’s vicious bear market is that there have been no safe harbors for investors — no stock market sector has performed well, no foreign market has thrived, alternative investments have largely declined. Even in the bond market, only short-term Treasuries have positive returns. In other words, contrary to past experience and to theory, the performance of diverse investment assets has become very highly correlated, almost to the extreme of all having a correlation coefficient of one. I would suggest this is more evidence that our markets have become “overspeculated.” By overspeculation, I mean that trader cash flows are determining pricing of assets more than fundamental merits. While this suggests long term opportunities for patient investors, it is an unhealthy market condition.
Coefficient of 1.0