Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner

4-Jun-2006
Correlated Assets, by Kim Zussman

Recent discussions about tandem movement of various asset classes prompts the question as to what, if any, effect this has on stocks. One way to look at this is to check whether correlation of bond and stock moves has an effect on subsequent returns for stocks.

TNX (10 yr treasury yield) weekly closes since 1962 were inverted to give a proxy for bond price, and from this weekly change in bonds was calculated. The SP500 index weekly closes over the same period were used for stock weekly change. At the end of each year, correlation was calculated for change in bonds with change in stocks, looking back over the prior 50 weeks. The return of stocks over each subsequent year was regressed against the prior year's correlation of change in stocks and change in bonds:

```Regression Analysis: sum nxt y versus cor st int

The regression equation is
sum nxt y = 0.0529 + 0.330 cor st int

Predictor      Coef  SE Coef     T      P
Constant    0.05291  0.02645  2.00  0.052
cor st int   0.3304   0.1675  1.97  0.055

S = 0.145077   R-Sq = 8.7%   R-Sq(adj) = 6.4%```

Higher correlation last year between change in stocks and change in bonds predicts higher return in this year's stocks, though the relationship was just shy of significance. 2005 correlation was about 0.08, so with any decent threats from the turban-beard crowd stocks should be up in 2006.

Here are the years and correlations between weekly change bonds and stocks:

```year cor st int
2005 0.077
2004 -0.039
2003 -0.037
2002 0.040
2001 -0.026
2000 -0.022
1999 -0.053
1998 0.088
1997 0.013
1996 0.297
1995 0.007
1994 0.003
1993 0.000
1992 0.023
1991 0.190
1990 0.190
1989 -0.067
1988 0.145
1987 0.332
1986 -0.102
1985 0.102
1984 -0.009
1983 0.259
1982 0.254
1981 0.184
1980 0.307
1979 0.152
1978 0.095
1977 0.049
1976 0.122
1975 0.280
1974 0.164
1973 -0.147
1972 0.086
1971 0.213
1970 0.334
1969 0.073
1968 0.081
1967 0.207
1966 0.110
1965 -0.013
1964 0.026
1963 0.066
1962 -0.256```