Which national stock market index performed the best? Often a stock index rallies while its currency devalues, leading to a zero-sum game in dollar terms. The charts above convert each index into US Dollars, allowing for an accurate perfomance comparison.
The chart above displays a heat map illustrating the correlation coefficients among various national stock market indices. Each index is represented on both the x and y axes, with intersections revealing the strength and direction of their correlation. A correlation coefficient of +1 indicates a perfect positive correlation, indicating that two indices moved in the same direction during the specified time window. Conversely, a coefficient of -1 signifies that the indices moved in opposite directions. Colors range from deep blue, indicating a negative correlation, to bright red, signifying a strong positive correlation.
The correlation coefficient is important to consider for diversification because it helps investors assess the potential benefits of including different assets in their portfolios. Diversification is the practice of spreading investments across different asset classes to reduce risk. In his book Principles, Ray Dalio called diversification the “Holy Grail of Investing”. He realized that with fifteen to twenty uncorrelated return streams, he could dramatically reduce the risks without reducing the expected returns.
The minimum spanning tree (MST) simplifies the data from the correlation matrix above by retaining only the strongest correlations between the national stock market indices. If two indices are connected, it means that they are positively correlated and that they tend to move in tandem. By analyzing the structure of the MST, one can identify clusters of indices that move together. This visual tool is especially beneficial when considering international portfolio diversification. In fact, Marti, Gautier, et al. (2017) found that the optimal Markowitz portfolio is found at the outskirts of the tree and that the tree shrinks during a crisis.
An error appeared while loading the data. Maybe there is a technical problem with the data source. Please let me know if this happens regularly @silvan_frank.