Since the Great Financial Crisis in 2008, correlations across asset classes during periods of rapidly rising volatility have moved towards 1 fairly consistently, producing little to no diversification beneft. In examining asset class correlations on 1-,3- and 5-year bases (as of 3/5/2018), we observe a high level of stability, reflecting stable to declining levels of stock volatility (as measured by standard deviation).
However, as stock volatility picked up in early 2018 we observed meaningful increases in correlations across long-term bonds and commodities (Note: correlations also increased meaningfully relative to international stocks, including emerging markets). Not surprisingly, the short-term bond correlation with stocks became more negative during the period of heightened volatility as investors sought safety.
In examining returns of ETFs representing the asset classes under consideration, we see returns were negative in the month of February for all asset classes, including short-term bonds (albeit very slightly negative). Apart from short-term bonds, other traditional diversifying asset classes didn’t provide any real diversification benefit. Granted, it was a very short period of time.
An ETF representing Japanese Yen, whose correlation with US stocks is among the most negative historically, not surprisingly produced a positive return during February of this year when most other asset classes had negative returns. Currencies haven’t always been considered when establishing individual investor asset allocations for various reasons. However with vehicles like currency ETFs available now, incorporating currencies into individual asset allocations for diversification benefits might make more sense.