The Investment Scientist

Why did correlations go to one?

Posted on: September 24, 2009

My friend Carl Richards made an interesting observation in his last post:

Just when we need something to zig, they all zagged together!

FearSome people draw the conclusion that diversification no longer works. I strongly disagree.

In a crisis, the only factor driving asset prices is fear. Fear does not discriminate, and fear spreads far and wide in lighting speed. That is why all risky asset classes “zagged together.”

But fear is not a permanent human condition. Whatever crisis we are in, eventually we will get out of it! Even if we don’t get out of it, we get used to it.

Sooner or later, correlations will come down. Asset classes will zig and zag to different tunes again.

This article was first published on Morninstar Advisor.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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