It is commonplace now to talk about break down of the risk-on/risk-off (RoRo) matrix and in particular the decoupling of the euro from the S&P 500. Be careful. Most observers were slow to recognize this decoupling, which we had been writing about for some time, and are missing the more recent trend in which the linkage has tightened.
Our methodological point is that it is difficult to accurately eyeball correlation. Correlation is a statistical relationship. Many observers see the euro off 2.7% against the dollar this year and recognize that the S&P 500 is up 8% and see this as a sign of a weak correlation.
Look at the data though, and a different picture emerges. As investors, we are most interested in the correlation of returns. To gauge this we look at the correlation of the percent change in the euro and the percent change in the S&P 500.
Over the past 60-days the correlation stands at 0.44. This is well above the low set in early February near 0.25, which was the lowest correlation since March 2011. The 60-day correlation finished 2012 near 0.41.
Moreover, the 30-day correlation is substantially higher near 0.68. It bottomed in early January below 0.1, the lowest in a year. The current reading is just below the last peak in Oct. 2012 near 0.70. That the 30-day is so much higher than the 60-day correlation indicates that the relationship between the euro and the S&P 500 is much tighter currently than those simply looking at the charts can appreciate.
When running correlations between the euro an interest rate or spread, we find that conducting the study on percentage change is often misleading (percentage change of a percent) and opt to look at levels or values. We continue to point out how well the U.S.-German 2-year interest rate spread tracks the euro-dollar exchange rate. The 60-day correlation is at 0.75, at the stronger end of where it has been over the past several years. The 30--day correlation is about 0.93.
The other relationship that investors are presently sensitive to is that between the euro and Italian debt. The euro and the Italy's 2-year yields are inversely correlated (-0.55). At the end of January, that is, before the Italian election, the inverse relationship was even greater at -0.85.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.