If risk on/risk off is off, what’s on?

It had all been so simple. Good news on US jobs? Buy equities, commodities, emerging markets, and sell bonds. New eurozone wobble? Sell equities, commodities, emerging markets, buy bonds.

But there has been a barrage of recent evidence that markets may be entering a new and more complicated era, where large asset classes no longer move predictably in lock-step depending on the prevailing mood of optimism or pessimism over the global economy.

In other words, they may be entering a period where evaluating the fundamentals of particular commodities or countries or individual stocks might be more effective.

That has certainly been the case within the US equity market over the past month, where the correlations between stocks have collapsed.

Stacy Williams, head of foreign exchange quantitative strategy at HSBC, begins with a note of caution. It requires long periods of data to establish correlations and also, therefore, to establish if they are breaking down.

Nonetheless, something has changed. Instead of being negatively correlated, bonds and equities suddenly seem to be positively correlated. And none of the linkages are quite as tight as they have been for the past five years.

“When the crisis hit, correlations went to the moon and stayed there, and asset classes became either ‘risk on’ things or ‘risk off’ things,” he says.

“Since the start of 2013, correlations have fallen dramatically but they have not gone back to normal. In fact, the whole correlation spectrum has been going mad. Everything seems to be correlated with ‘risk on’. Almost nothing is negatively correlated with equities now, and there are no safe havens any more.”

Theories for the lower levels of correlation between and within asset classes centre on the normalisation of the global economy after long years of crisis, first emanating from US housing and then from the eurozone periphery.

The US Federal Reserve has signalled it wants to move beyond its use of quantitative easing, which was designed to drain the system of risk-free assets and force investors into risky ones, a programme it has been apt to dial up or down depending on the fragility or otherwise of the global economy.

High correlations may be more than just the result of proximity to crisis, however. The amount of money in index-hugging exchange traded funds, which give institutional and retail investors alike easy access to pools of commodities, bonds or emerging markets stocks, passed $2tn this year.

A Bank for International Settlements report last month concluded that commodities were not a good way of diversifying a portfolio since they have become highly correlated with equities, and blamed in part for an influx of speculative money that has turned commodities as a whole into an asset class.

But correlations between globally traded commodities have been trending lower this year, as investors in agricultural goods worry about bumper harvests, industrial metals investors place bets on the Chinese economy and oil moves to a separate tune.

It is within US equities where the stockpickers have really come to the fore in recent weeks, as correlations plunged. A Citigroup measure of rolling one-month correlation between moves in the top 50 stocks of the S&P 500 fell to 12 per cent this week, from 66 per cent at the end of June. It briefly dipped below 10 per cent at the start of February but has otherwise not been lower in five years.

Tobias Levkovich, chief US equity strategist at Citigroup, worries about investor complacency. While stockpickers are digging about in the idiosyncrasies of individual stocks, he says, they may not be paying attention to the macroeconomic picture.

Equity prices are more likely to be right if there is a balance, he says.

“When you have these 24/7 macro freak-outs and correlations are high, that is when you have pricing distortions and as an investor you should be jumping on these. On the other hand, you don’t want macro to be a non-event, because it will be an event again in due course.”

Peter Tchir, founder of TF Market Advisors, warns that correlation can be a tricky guide to investing, since correlation does not equal causation, but he agrees that focusing on the macroeconomic outlook is often better than being beguiled by stockpicking.

“All stocks will be better if we have two million jobs created rather than 500,000 lost, so the ‘macro’ correlation is a key driver – always has been – but people prefer to believe individual stock and bond picking is best.”

HSBC’s Mr Williams says that a new picture will take time to emerge. “There was not a lot of point worrying about delicate imbalances in the supply of copper if the world was going to fall into another crisis. Now the story has changed again, but we haven’t quite made sense of it yet.”