Crossing Wall Street has an interesting set of graphs that show the S&P 500 versus the Euro. At least for the end of the year it shows what most market observers probably thought – the US equity market was correlated to the Eurozone.
In October and November the Euro and the S&P 500 were highly correlated. So as the Euro got stronger the S&P 500 increased in value. If this seems contradictory, remember as the crisis in Europe grew the appetite for risk would fall and the flight to quality would grow. Thus, investors would sell stocks and the Euro and move into Treasuries, for example.
What has happened in January? The correlation has essentially stopped. What does this all tell me?
- Could be nothing, very small sample size
- If it is something, the big drag from Europe wasn’t so much a slowing economy but a financial system collapse
- The risk of the latter has been reduced, at least for now
- The former was already priced in
- Thus, assuming the correlation means something, negative economic news from the Eurozone will probably have minimal impact on US markets (assuming US data stays positive)
- If however the risk in financial markets comes back, the correlation could come back
