Chart: The Stock Market is Decoupling from 1929 Correlations

Jonas Elmerraji, CMT

History doesn’t repeat, but it does rhyme.

And, more recently, that’s been a little concerning for investors because of which years 2020’s stock market rout and rebound have been rhyming with: 1929 and 1987.

(Here’s the recap in case you missed it.)

Those are two market crash years where stocks had exceptionally similar correlations initially, only to wind up with vastly different outcomes.

Heading into this summer, it looked like 2020 was tracking much more on pace with 1929 than 1987.

Now, though, it looks like the relationship is decoupling:

Current_correlations

In the chart above, the dark blue line shows 2020’s price performance, with 1987 in teal and 1929 in red. (Trading days from 1987 and 1929 are sped up to account for 2020’s record snapback rally. More on that at the end.)

While the magnitudes of the moves are slightly different, the turning points of the major trends clearly synch up incredibly closely.

In the prior periods, the correlations decoupled from one another around day 100 in 2020-scaled trading days.

The last time we checked on this relationship, we were right at that 100-day mark. So, what’s happening now?

The recent rally in the S&P 500 lines up well with the equivalent bump higher from 1987.

We’re slowly seeing that translate into the rolling correlations for each year:

rolling_correlations_2020
Rolling correlations with 1929 are plunging, while 1987 turns higher. Both remain high in absolute terms.

While it might seem like shifting back towards a strong analog with 1987 is a good thing – after all, stocks still managed to end that year in positive territory and posted double-digit returns the following two years.

(And economically, tracking 1987 makes a lot more sense given the Fed’s unprecedented intervention this year.)

But because high correlations with prior crash environments reflect uncertainty in the current market more than the risks of history simply repeating, we’re really just trading one concerning stat for another.

High correlations with either prior year suggest that there are idiosyncratic risks that aren’t priced in right now.

What we’d rather see here is 2020’s price action completely decouple from both of these highly correlated prior periods. That’s the signal that investors are finally pricing 2020 based on new information specific to this year, not merely trading on autopilot.

I’ll keep on monitoring these relationships in these pages.

In the meantime, despite the longer-term dark clouds, the broad market price trends still favor higher ground this summer.

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