The Euro and S&P 500 don’t have a very high correlation over a long period of time. In non-geek speak, that simply means that the movement in one does not translate to a movement in the same direction of the other all that often. For a quick lesson in correlation, statistically, a correlation of 1 between two variables is considered to be “perfect” correlation, meaning that the two move in tandem, all the time. -1 indicates an inverse correlation, meaning that two variables move in totally opposite directions all the time. A correlation of 0 simply means there is no correlation; the change in one security means very little to the change in the other. When I computed the historical correlation between the Euro and S&P 500 on Bloomberg, it is as low as 0.035, meaning there is very little long term correlation (it’s close to 0).
Lately, much market myopia has been on the evolving crises in the Euro-zone, and the correlation between the two has been increasing. Bloomberg indicates a correlation of 0.5 now, but anyone that’s been watching tick-by-tick trades knows that moves in the Euro often appear to lead the equity markets these days. If you don’t believe me, then I suggest that you start watching the daily charts of the Euro exchange traded fund (FXE) vs. the S&P 500 (SPY). Why does this seem to be the case? Well, I suppose we could blame it on hedge funds, computer linked trading devices, or the fashionable scapegoat du jour, which happens to be BP. Whatever the real reason is for the increase in correlation, we may never fully know. However, if you want a clue as to which way equity markets may be headed, just follow the Euro.
