How Correlated Are Global Markets?

Includes: DIA, QQQ, SPY
by: Zubin Jelveh

A little while back, I looked at how stock market volatility had jumped higher in the U.S. since Sep. 15, particularly in the last hour of trading. But the current downturn is a global one, so I thought I'd also take a look at a couple of other markets around the world and check out the interactions.

I grabbed hourly trading data for three indices: S&P 500, Japan's Nikkei 225, and France's CAC 40 -- I couldn't get it for the FTSE. The following chart shows the average change in the indices for a typical 24-hour period for 40 trading days prior to the Lehman bankruptcy:

This chart shows the same, but for 40 trading days post-collapse:

Some immediate takeaways:

  • If you compare the U.S. section of the second chart with the one I did from about a month ago, you'll notice that volatility hasn't declined much at all.
  • The opening hour in Japan had the biggest price changes both before and after Lehman, but it was the closing hour for Japan that saw the biggest jump in price changes across the three indices. In fact, outside of the lunch hour where the markets are closed, the closing hour used to be the least jumpiest.
  • Overall, the magnitude of the jumps in price changes is about the same across the three markets.

A more interesting investigation is to see how much the markets are connected. In a globalized world undergoing a crisis, does one market pretty much follow the other until some major news event breaks? There are many potential confounding variables here and getting a clear answer is probably hard to do, but let's try anyway.

The following set of charts compare the index changes for two different countries on the same trading day. For example, Japan's market opens four hours after U.S. trading ends, and if Japan follows the U.S., then we should see a roughly straight line from the lower left to the upper right.

So, the first chart shows the daily index changes of the Nikkei (x-axis) vs. the S & P (y-axis) before Lehman:

And this is after Lehman:

Japanese shares do certainly look like they've become more correlated with U.S. stocks over the past two months. If we only look at the first hour of trade in Japan, the pre-picture becomes slightly more correlated but the post picture becomes much more so:

Let's next take a look at France and the U.S. Trading in those two countries overlaps for three hours each day, so the next two charts show index changes for the CAC (x-axis) and the S & P (y-axis) during those hours before and after Lehman:

Looks like France and U.S. were pretty well correlated both before and after Sep. 15.

Finally, here's Japan (x-axis) versus France (y-axis) (the CAC data in the plots below don't include the times that the U.S. market was also open):

There was very little association between Japanese and French stocks prior to September, and quite bizarrely, there's been a negative association since. I'm not quite sure what to make of that. Are French investors seeing the East as a contrarian indicator? Any other ideas?

Still, this is further evidence that, in one way or another, we're all in this together.