Btw, from what I've read lately, markets are growing more and more correlated because of the interconnectedness and interdependence of the multinationals. However, Morningstar just claimed that foreign small cap and foreign emerging markets were somewhat decoupled from these correlations. Do you believe that? And, if so, have you seen articles/links that give more of an explanation?
For anyone that is interested, the answer is "don't believe it": http://www.usatoday.com/money/perfi/columnist/netgains/2003-05-01-r-squared_x.htm Why R Squared? In last week's Investing column, I wrote about the tight correlation between international stock funds and U.S. large-company stock funds (International funds lose their cachet). Several readers then asked: How closely correlated are international small-cap funds with their U.S. counterparts? The answer, in a word: Very. International small-company stock funds are relatively new creatures: Lipper has only tracked them since 1996. They have been inspired, in part, by the fact that some funds that invest in Japanese small-company stocks have held up fairly well, at least compared to the dismal performance of the Japanese stock market as a whole. As you might suspect, small-company stock funds have not been a fun place to be the past 12 months. The average small-company core fund has tumbled 21.5%, Lipper says. International small-cap funds, however, have fallen just 16.1%. Can you make the argument that small-cap international funds will ease the pain (or increase the pleasure) of small-company stock funds? Although we don't have a ton of data, what we have suggest that small-cap international funds do pretty much whatever small-cap U.S. stock funds do. The past three years, the two types of funds have an 87.89% correlation. A 100% correlation is a perfect match. Another way to look at the relationship between the two types of funds is a statistical measure called r-squared. This measure shows how much of the returns from one kind of fund is derived from the returns of another. Using the most recent r-squared data, we see that 77.3% of the returns from international small-company stock funds depends on the performance of their domestic brethren. So if you're wondering whether to take your small-company international investing abroad, you can probably do just as well at home. But international bond funds, particularly emerging markets bond funds, do seem to have very little correlation with U.S. government securities funds. A portfolio of 20% emerging-markets debt funds with 80% government securities funds did boost your overall returns. The danger: Like international small-company stock funds, international emerging-markets debt funds don't have a great deal of history behind them. And when you buy emerging-market bonds, you're buying long-term IOUs from countries with massive currency risk â as well as sovereign risk, which is the likelihood that the government will disappear overnight. So if you add any emerging markets bond funds, add them sparingly.
Markets are growing more and more correlated because of excessive diversification. If portfolio managers around the world are buying a little bit of everything, ultimately they all tend to end up with very similar looking portfolios. Since they tend to base their buy/sell decisions on the same information, they tend to rush into and out of the same things at the same time. The managers can delude themselves into thinking that they are acting as a rational individuals but the reality is that they are acting like a mob based on their collective actions. Larger-cap stocks would be most actively traded before medium-cap and smaller-cap stocks in progressively smaller markets get drawn into the maelstrom.
What you're saying makes sense and is verified by what this guy ran - probably in Excel! - to check the correlations of small cap US to small cap int'l. It's int'g that int'l bond funds are uncorrelated...