This A. Stotz Academic-Style Research focus on answering the question: Decoupling or Increased Correlation Across the Globe? We look into correlation among asset classes and how this correlation has changed over time. Read the full article to learn how to diversify effectively. Learn more at: http://becomeabetterinvestor.net/blog/decoupling-or-increased-correlation/

1. Presented by: Andrew Stotz, CFA 25 May 2016
Decoupling or increased
correlation across the globe?

2. 25 May 2016 2
 Ask a research question
 Summarize previous research
 Formulate a hypothesis to test
 Select a relevant data set, remove errors and outliers
 Formulate a methodology to test the hypothesis
 Present and analyze the results
 Advise how to apply to improve investment decisions
Our academic-style research format
Source: A. Stotz Investment Research
Hypothesis
Method
Results
Question
Review
Action
Data

3. 25 May 2016 3
Hypothesis
Method
Results
Question
Review
Action
Data
Correlation between three major asset classes
Source: A. Stotz Investment Research
 What benefit can you get from diversifying across:
• The three major asset classes?
• Emerging and developed markets?
• The ten major sectors?
• Countries?
• Stocks?
 Does it add more or less diversification benefit now
compared to the past?

4. 25 May 2016 4
Hypothesis
Method
Results
Question
Review
Action
Data
 Investigated the degree of global cyclical
interdependence during 1960-2005
 Three groups: Industrial countries, emerging markets,
and other developing economies
 Concluded that business cycles within the groups had
converged, but became less synchronized between
industrial economies and emerging markets
 Mixed
Kose, Otrok, and Prasad (2008): Mixed conclusion
Sources: A. Stotz Investment Research, Kose, M.A., Otrok, C. and Prasad, E.S., 2008. Global business cycles: convergence or decoupling? (No. w14292). National Bureau of
Economic Research.

5. 25 May 2016 5
Hypothesis
Method
Results
Question
Review
Action
Data
 Investigated links between banks in developed countries
and emerging market bond, stock and credit markets
during the 2008 global financial crisis
 Conclusion: No decoupling at time of crisis. Liquidity and
bank solvency measures had become more correlated
with emerging market bond, stock and credit markets
during that crisis period
 Highly correlated
Frank and Hesse (2009): High correlation between EM and DM assets
Sources: A. Stotz Investment Research, Frank, N. and Hesse, H., 2009. Financial spillovers to emerging markets during the global financial crisis (No. 9-104). International
Monetary Fund.

6. 25 May 2016 6
Hypothesis
Method
Results
Question
Review
Action
Data
 Looks at deviations from GDP trends rather than actual
GDP growth rates on data from 1980-2008
 Rejected decoupling in the years before the global
financial crisis, and concluded that business cycle
interdependence had become stronger
 Highly correlated
Wälti (2012): Rejects decoupling
Sources: A. Stotz Investment Research, Wälti, S., 2012. The myth of decoupling. Applied Economics, 44(26), pp.3407-3419.

7. 25 May 2016 7
Hypothesis
Method
Results
Question
Review
Action
Data
 Tested decoupling in two ways in 1993-2010: Real
decoupling – Sensitivity to business cycles and other
economic factors such as GDP, and Financial decoupling
– Sensitivity of emerging market assets (credit, equity
and FX returns) relative to a global market portfolio
 Concluded that business cycles in emerging markets
have gradually decoupled from developed markets
 Rejected financial decoupling as they could see high and
increased ‘comovement’ in EM assets
 Highly correlated
Yeyati and Williams (2012): Rejects financial decoupling
Sources: A. Stotz Investment Research, Yeyati, E.L. and Williams, T., 2012. Emerging economies in the 2000s: Real decoupling and financial recoupling. Journal of
International Money and Finance, 31(8), pp.2102-2126.

8. 25 May 2016 8
Hypothesis
Method
Results
Question
Review
Action
Data
 Looked at US (developed) and Poland (emerging) GDP
growth rates’ dependency on the underlying long-term
GDP trend
 Compared deviations from the long-term GDP trend
 Conclusion: No evidence to support decoupling,
the Polish economy was well synchronized
with that of the US
 Highly correlated
Wyrobek and Stańczyk (2013): High correlation between EM and DM
Sources: A. Stotz Investment Research, Wyrobek, J. and Stańczyk, Z., 2013. Decoupling hypothesis and the financial crisis. European Financial Systems 2013, p.362.

9. 25 May 2016 9
Hypothesis
Method
Results
Question
Review
Action
Data
 There are diversification benefits (relatively low
correlation) to gain from investing in different asset
classes, regions, sectors, countries and stocks
 Correlation will have increased over time in all the
above cases
Hypothesis
Source: A. Stotz Investment Research

10. 25 May 2016 10
Hypothesis
Method
Results
Question
Review
Action
Data
 We collected price data for MSCI indices from December
1994 to September 2015
 Indices for bonds, commodities, and world equity
 Equity indices for developed markets, emerging
markets, global sectors, and countries
 For company level correlations we used a data set of
about 27,000 companies listed anywhere in the world
beginning in March 2002 and ending in May 2015
MSCI indices and a universe of 27,000 international stocks
Source: A. Stotz Investment Research

11. 25 May 2016 11
Hypothesis
Method
Results
Question
Review
Action
Data
 We calculated the returns of the indices and the stocks
 Then calculated the pairwise correlations between asset
classes, regions, sectors, and companies
 Looked at the average correlation within each grouping
 For asset classes, regions and sectors we looked at a 10
year rolling correlation
 For companies we calculated the 3 year rolling
correlation as the data set spanned a shorter time
period
Comparing average rolling correlations
Source: A. Stotz Investment Research

12. 25 May 2016 12
Hypothesis
Method
Results
Question
Review
Action
Data
Correlation: Increased correlation after the global financial crisis
Sources: A. Stotz Investment Research, Thomson Reuters
3 asset class average
pairwise correlation
increased to 45% from
14%
Diversifying across
asset classes still offers
benefits, but less so
Correlation was low
during stock market rise
(peaked in Oct 2007)
Switched to very high
(and rising) by Feb 09
equity trough
14
45
-
10
20
30
40
50
60
70
80
90
100
Mar-05 Sep-07 Mar-10 Sep-12 Mar-15
Bond, Equity, Commod.10yr-rolling correlation (%)

13. 25 May 2016 13
Hypothesis
Method
Results
Question
Review
Action
Data
Equity and bonds are no longer uncorrelated
Sources: A. Stotz Investment Research, Thomson Reuters
Correlation between
global equity and global
gov’t bonds has
increased to 35% from
3%
Equity and bonds
correlation shifted up
Correlation between
EM equity and
commodities has
doubled to 62% from
34%
No decoupling
3
35
34
62
(10)
-
10
20
30
40
50
60
70
80
90
100
Dec-05 May-08 Oct-10 Mar-13 Aug-15
Global equity vs Global gov't bonds
EM equity vs Commodities
10yr-rolling correlation (%)

14. 25 May 2016 14
Hypothesis
Method
Results
Question
Review
Action
Data
Correlation: Increased correlation after the global financial crisis
Sources: A. Stotz Investment Research, Thomson Reuters
Correlation between
EM and DM equity
markets has increased
slightly to 87% from 77%
Implies increased
financial integration and
fewer benefits from
diversification between
EM and DM
But they were always
highly correlated at this
aggregate level
No decoupling
77
87
14
45
-
10
20
30
40
50
60
70
80
90
100
Mar-05 Sep-07 Mar-10 Sep-12 Mar-15
Developed vs emerging
Bond, Equity, Commod.
10yr-rolling correlation (%)

15. 25 May 2016 15
Hypothesis
Method
Results
Question
Review
Action
Data
Correlation across sectors has increased massively
Sources: A. Stotz Investment Research, Thomson Reuters
The average correlation
among the 10 major
global sectors has risen
to 79% from 53%
Diversification benefits
across sectors have been
drastically reduced since
the crisis
77
87
14
45
53
79
-
10
20
30
40
50
60
70
80
90
100
Mar-05 Sep-07 Mar-10 Sep-12 Mar-15
Developed vs emerging
Bond, Equity, Commod.
Sectors
10yr-rolling correlation (%)

16. 25 May 2016 16
Hypothesis
Method
Results
Question
Review
Action
Data
Correlation: Country-level diversification still offers benefits
Sources: A. Stotz Investment Research, Thomson Reuters
The average correlation
across countries has
increased from 36% to
55%
At the country level, it
is easier to benefit from
diversification, even
though correlation has
increased
No decoupling
77
87
36
55
14
45
53
79
-
10
20
30
40
50
60
70
80
90
100
Mar-05 Sep-07 Mar-10 Sep-12 Mar-15
Developed vs emerging
Countries
Bond, Equity, Commod.
Sectors
10yr-rolling correlation (%)

17. 25 May 2016 17
Hypothesis
Method
Results
Question
Review
Action
Data
Good news: Stock pickers can still diversify
Sources: A. Stotz Investment Research, Thomson Reuters
The least amount of
correlation exists
between stocks
Though correlation
among stocks tripled
during the financial crisis,
it has been decoupling
since 2012
This means that a stock
picker can still construct
a highly diversified
portfolio
Stocks have decoupled
77
87
36
55
14
45
8 4
53
79
-
10
20
30
40
50
60
70
80
90
100
Mar-05 Sep-07 Mar-10 Sep-12 Mar-15
Developed vs emerging Countries
Bond, Equity, Commod. Stocks (3yr-rolling)
Sectors
10yr-rolling correlation (%)

18. 25 May 2016 18
Hypothesis
Method
Results
Question
Review
Action
Data
Grouping Begin Recent Level Change over period
Asset classes 14 45 Moderate Very large increase
DM vs EM 77 87 High Small increase
Sectors 53 70 High Large increase
Countries 35 55 Moderate Very large increase
Stocks 9 7 Low Small decrease
Equity market price correlation summary
Source: A. Stotz Investment Research

19. 25 May 2016 19
Hypothesis
Method
Results
Question
Review
Action
Data
 Correlation has increased over time, except for stocks
 Expect portfolios of indices’ to be highly correlated
 Construct portfolios of stocks to benefit from decoupling
Stock pickers can still diversify
Source: A. Stotz Investment Research

20. 25 May 2016 20
Know it first!
Get access to additional research & articles
Sign up for free membership and newsletter
Go to: becomeabetterinvestor.net/join

21. 25 May 2016 21
References
 Frank, N. and Hesse, H., 2009. Financial spillovers to emerging markets during
the global financial crisis (No. 9-104). International Monetary Fund.
 Kose, M.A., Otrok, C. and Prasad, E.S., 2008. Global business cycles:
convergence or decoupling? (No. w14292). National Bureau of Economic
Research.
 Wyrobek, J. and Stańczyk, Z., 2013. Decoupling hypothesis and the financial
crisis. European Financial Systems 2013, p.362.
 Wälti, S., 2012. The myth of decoupling. Applied Economics, 44(26), pp.3407-
3419.
 Yeyati, E.L. and Williams, T., 2012. Emerging economies in the 2000s: Real
decoupling and financial recoupling. Journal of International Money and
Finance, 31(8), pp.2102-2126.