Correlations Across Global Markets Are Falling, Raising Expectations For Asset Allocation Opportunities
By James Picerno | The Milwaukee Company | jpicerno@themilwaukeecompany.com
Return correlations for the major asset classes have fallen sharply so far in 2025.
The median pairwise correlation across a set of ETF proxies for global market for daily returns over the trailing 1-year window is currently 0.52, well below the recent peak.
Lower correlations imply an enhanced climate for adding value with global asset allocation strategies.
The outlook may be improving for strategies targeting global asset allocation. Or so it appears, based on the recent slide in daily return correlations across global markets via a set of ETF proxies.
Following a post-pandemic surge in return correlations for the major asset classes, the median has recently reversed course and has fallen to roughly 0.5 through Mar. 12. The sharp decline started in February after peaking last summer at 0.66. Correlations range from -1 (perfect negative correlation) to +1 (perfect positive correlation), and so the current level reflect a moderately positive relationship for markets overall.
The dramatic pullback suggests that a new regime of relatively low-to-moderate correlations may be dawning. If so, the downshift opens the door for enhanced opportunities for designing and managing globally diversified portfolios. By contrast, when correlations are relatively high, the value of diversification fades, if only in relative terms.
To illustrate the point with an extreme example: In a world where all assets are perfectly correlated (+1.0), there would be no advantage to diversification because any one asset would move in lockstep with everything else.
In the real world, of course, assets are never perfectly correlated. Rather, it’s a matter of degree. Even at last year’s peak correlation mark, the median reading for the major asset classes was 0.66, or well below 1.0. This year’s decline suggests that diversification opportunities are improving relative to recent history.
A more granular review of the individual comparisons highlights dramatically lower, and higher, correlations for some pairs of assets vs. the median. For example, the lowest correlation for the major asset classes for daily returns over the past year is 0.02 for US bonds via Vanguard Total Bond ETF (BND) vs. a broad measure of commodities (DJP). By contrast, the highest correlation pairing is 0.86 for global corporate bonds ex-US (PICB) and foreign government bonds in developed markets (BWX).
To be clear, low or high correlations alone don’t determine investment results. Depending on the strategy, it’s possible that correlations may play a minor or even trivial role. Rather, correlations are a rough estimate of whether diversification, in theory, is a headwind or tailwind. Regardless, it’s one of several factors that ultimately govern a given asset allocation’s risk and return mix.
The good news: correlations generally are sliding, which equates with higher implied odds for potentially adding value by targeting a global opportunity set. Given the previously high level of the median correlation that’s only partly corrected to date vs. the historical range, it’s reasonable to expect that the recent slide may continue. In that case, the value of global asset allocation will likely continue to strengthen compared with recent history.
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