[Economics] Markets Fundamentals

Greed and fear played an important part in the market over the course of past 2 years, with volatile hopes and fears driving the ups and downs of stocks, bonds and commodities. Risk perception was the main driver of investor sentiments. Risk-on trades are undertaken by investors who move to invest in riskier investments, seeking higher returns (e.g. US investors buying foreign currencies, stocks, commodities and other risky assets), whereas risk-off attitude would see investors rushing to store wealth in forms of safe assets (e.g. the US dollar).

For much of last year, correlation between the strength of US dollar and stock market is strongly negative. As we see stocks were rising, it indicates positive sentiment (as investors are confident) and money would shift from 'safe heaven' to the stock market, and vice versa. It was a virtual mirror image of each other.

Same as commodities, higher risk appetite would generate higher demand for risky investments in forms of commodities.

This has reduced the fundamental pricing mechanism of various assets into oblivion. We could not deploy simple analysis across global markets, due to this frenetic interplay of asset classes. This has undoubtedly thwarted efforts of investors in making long term trades during much of 2010.

It is of a relief that there exists signs of these unusual relationships (or correlations) to be breaking down. The S&P 500 stock index and US dollar, valued against a basket of key trading partners' currencies, have a correlation of roughly 0.1, which is close to zero, meaning that the relationship between stocks and dollar is virtually nonexistent.

This could be explained by the US dollar no longer trace the risk appetite of investors, so that the reasoning that investors made (to buy US dollar for safety at low time and sell US dollar for riskier assets at high time) is no longer 'valid' in a sense.

To add more variables into play, gold and stock prices moved in unison as did gold and Treasurys. These relationships we saw last year have become unconnected lately.