Nikkei 225 and S&P500 Correlation Bad for Investors

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In today's Wall Street Journal Asia Edition, Jamie Miyazaki describes a Merrill Lynch strategist's finding that Japanese and U.S. stocks remain highly correlated in HEARD IN ASIA: Have U.S. and Japan Markets 'Decoupled'? Strategist Says No.

Thought you were benefiting from diversification by investing in Japanese stocks? Think again, says Merrill Lynch's Tom Cotroneo, a Japanese equity-derivative strategist who says:

"The Nikkei has been trading in the top of its correlation range with the S&P 500, and the assertion that the two markets have been -- or are -- de-linking is essentially false."

Cotroneo thinks the largely lock step trading will persist at least until the end of the year. What's more is the 225 component stocks of the Nikkei 225 Stock Average are also exhibiting a very high correlation across all sectors meaning stocks are moving more on macroeconomic factors than stock-specific factors. Cotroneo comments:

"This is one of the biggest sources of risk. Very correlated markets are more volatile and more risky, as there is little diversification and the safety it can bring."

Comments: Cotroneo's findings are not all that surprising if you follow the Nikkei. I have written about the high level of correlation in the past and particularly after the Fed's May 10th rate hike (see Japan is Seeking Beta). However, this trend is both disturbing and frustrating because almost any Japan analyst can tell you that although exports remain an important part of the Japanese economy, domestic demand is now the main driver of growth. Resources: Recent articles on investing in Japan include: Japan Strategist Bullish Short-term, But Sees End to Rally, Nomura's Individual Investor Survey for August: Caution Prevails, Another BoJ Rate Hike This Year?, Dollar Could Tank vs. Yen By End of Year, and Signs of an Impending Japanese Crash Abound.

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