Another Correlation Gone Awry?

03/13/2013 9:00 am EST


It is never safe to assume that long-standing correlations can continue indefinitely as pointed out by Greg Harmon of Dragonfly Capital, so traders need to trade the market they currently see.

One reason that many traders are skittish or do not trust the current market move has to do with inter-market analysis. We have been taught that there are certain relationships between markets and understanding them can give you a leg up in certain markets as to when a change may be coming.

One of these relationships is that between the US Dollar Index and the S&P 500. Common knowledge is that these are inversely correlated, so that if the US Dollar Index is rising, the equities must be falling. The US Dollar Index is currently rising, and this is why traders are skittish. I have two responses to that. The first one is to trade the markets that you see. This means if equities are rising and the Dollar Index is rising, there is no need to bet against either one.

Click to Enlarge

If you don't like that answer, then how about a few statistics. The chart above shows the weekly action in both the US Dollar Index (upper line) and the S&P 500 over the last 15 years. The long blue boxes represent the times during that span that the US Dollar Index and the S&P 500 were positively correlated, as has been the case over the last few weeks. There have been five of these over the 15-year span, and they have ranged from six months in 2010 to two years from 1998 into 2000. This is over 1/3 of the time.

The current box, VI, is just getting started. It could last another five months at least. Do you really want to sit out on the sidelines waiting for the 'usual' correlation to come back before jumping in, and watch this market go higher?

By Greg Harmon of Dragonfly Capital

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