The S&P 500 / Aussie Correlation & Fractal Geometry

The S&P 500 and the Australian Dollar have a strong positive correlation because they are both widely held and heavily traded asset class markets. Not only do they often move in lock-step on the higher time frame weekly and daily charts – see figure 1—but true to the fractal nature of markets they also hold that correlation down into the intraday time frames – see Figure 2  a snapshot of the 3-minute charts taken this morning – 3-12-12. 


Figure 1 Daily S&P 500 and AUDUSD

Notice the small white boxes on the right side of both daily graphs in Figure 1. Currently the Australian Dollar is moving lower relative to the U.S. dollar, while the S&P 500 is still moving higher.  When we see this type of behavior we can say the correlation is weakening.  While there are current fundamental occurrences in place that are favorable for both markets, the individual reasons why both markets are bulls are essentially the opposite. The Australian Central bank made the long-term decision to maintain interest rates at the tail end of the last decade at a time when many of its major trading partners had decided to lower borrowing costs to protect businesses caught in slowing economies. Higher interest- rates relative to the other global economies attracted savings and investments into Aussie denominated investments, strengthening that currency. The S&P 500 on the other hand is in a bull market because the U.S. Fed adopted an overly accommodative interest –rate policy at the end of the last decade which lowered borrowing costs substantially in the U.S., and the U.S. Fed and Treasury went so far as to buy stocks and corporate debt outright to quell fears in the marketplace and get corporate borrowing back on track.  The S&P 500 also benefits from sizable twice a month in-flows from U.S. and global 401K holders, and a cheap dollar because of the Fed’s low interest rate policy which helps these 500 blue chip companies increase their already sizable global foot-print. Back to the relationship between the two markets, despite the near 90% correlation at times, they are two separate markets with their own nuances. Is the current deviance to the correlation shown on the daily chart telling us that something has changed in the marketplace now, which might signal the historic correlations is weakening? Experience, and fractal geometry tells us:  “Not likely”.


Figure 2 Intraday S&P 500 and AUDUSD

You may wonder why we show such short-term charts as the 3-minute?  Number one: it clearly shows that there is still an existing correlation. And number 2 we believe that markets typify fractal geometry where what happens on the higher time frames is replicated on the lower time frames.  Therefore if markets are correlated they must be correlated on both the higher time frames and the lower time frames, and every time frame in between.             

Given these two asset class markets are still so tightly correlated on an intraday basis we deduct that the degree of negative correlation shown on the higher time frame daily chart from last week is temporary, and similar to how the markets behaved in the first half of November, 2011when the Aussie accelerated lower while the S&P’s moved sideways.  If this negative interference between the two markets is telling us anything it is that we are very likely entering a counter-trending environment, and we should not expect coordinated trending action, i.e. larger moves, until the markets have consolidated the sizable 3-month rally from December thru February. In fact in counter-trending markets traders will often take direction from lower time frame patterns and direction, which is the opposite of trending markets where traders have little choice but to move with coordinated longer-term trends such as we just saw in January and February.   

The most significant potential economic determinant for these markets in our estimation is still the wall of institutional money waiting to buy dips in both these markets.

Trading involves substantial risk of loss and is not suitable for all investors!

Jay Norris is a trading instructor at IBUniversity.com and the author of Mastering the Currency Market, McGraw-Hill, 2009 and Mastering Trade Selection and Management, McGraw-Hill, 2011.

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About Jay Norris

Jay Norris is Director of Education at Trading University, has over 30 years of trading experience, and is the best selling author of "Mastering The Currency Market", McGraw-Hill, 2009, and "Mastering Trade Selection and Management", McGraw-Hill, 2011. He has also been published multiple times in Technical Analysis of Stocks & Commodities magazine.

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  1. Forex Crunches for the Weekend - March 24 2012 | Forex Crunch - March 23, 2012

    [...] Jay Norris talks about the S&P 500 / Aussie correlation and fractal geometry, after correlations underwent a shift. [...]

  2. Forex Crunches for the Weekend | Forex - March 24, 2012

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