- Investors tend to become more conservative and cautious after experiencing market bubbles and losses.
- Conventional wisdom suggests that higher risk is rewarded with higher returns, but research on the low volatility factor shows that low-risk stocks can outperform high-risk ones.
- Calculating correlations between long-short factors using monthly return data versus daily return data can yield dramatically different results, challenging established investing research.
- Correlations between the S&P 500 and foreign stock markets as well as US bond markets have consistently increased since 1989 due to globalization.
- US Treasury and corporate bond correlations with the S&P 500 vary over time, making them effective diversifiers for equity portfolios in the last two decades.
- When correlations are calculated with monthly return data, their range widens, providing a more accurate reflection of the history of global financial markets since 1989.
- Higher correlations between the S&P 500 and international stocks and US high-yield bonds make diversification more challenging.
- Daily return data is noisy, while monthly return data has fewer data points.
- Investors should maintain skepticism and stick with whatever data advises the most caution when making investment decisions.
Introduction
Investors tend to become more conservative and cautious after experiencing market bubbles and losses. While conventional wisdom suggests that higher risk is rewarded with higher returns, research on the low volatility factor shows that low-risk stocks can outperform high-risk ones. Additionally, calculating correlations between long-short factors using monthly return data versus daily return data can yield dramatically different results, challenging established investing research.
Daily Return Correlations
Correlations between the S&P 500 and foreign stock markets as well as US bond markets have consistently increased since 1989 due to globalization. US Treasury and corporate bond correlations with the S&P 500 vary over time, making them effective diversifiers for equity portfolios in the last two decades. The correlations among European, Japanese, and emerging market equities have also increased consistently.
Monthly Return Correlations
When correlations are calculated with monthly return data, their range widens, providing a more accurate reflection of the history of global financial markets since 1989. Japanese equities diverged from their US peers in the 1990s, while emerging market stocks were less popular with US investors during the tech bubble in 2000. US Treasuries and corporate bonds performed well when tech stocks turned bearish thereafter. US corporate bonds did worse than US Treasuries during the global financial crisis in 2008. Overall, the monthly return chart seems to more accurately reflect the history of global financial markets since 1989 than its daily return counterpart.
Daily vs. Monthly Returns
According to monthly return data, the average correlations between the S&P 500 and international stocks as well as US high-yield bonds have grown over the 1989 to 2022 period. This makes diversification more challenging for investors. Daily data is noisy, while monthly data has fewer data points and is statistically less relevant. Investors should maintain skepticism and stick with whatever data advises the most caution when making investment decisions.
Further Thoughts
Financial research seeks to build true and accurate knowledge about how financial markets work. However, changing something as simple as the lookback frequency can yield vastly conflicting perspectives. Investors should maintain skepticism and stick with whatever data advises the most caution when making investment decisions.
