To illustrate this point, Figure 11 presents the past and expected future rolling 10-year correlations of monthly stock market returns between the U.S. markets and a broad international index. The expected future distribution of U.S.-international stock market correlations is derived from the Vanguard Capital Markets Model (VCMM).[4] These estimates of future long-term correlations are based in part on the historical record and in part on reasonable assumptions about the likely course of global economic and financial integration. Historical evidence suggests that the financial and economic integration of different regions—through trade and financial flows—increases the correlation between these regions' financial markets and economies (Bekaert and Harvey, 2000).

Figure 11 shows that global correlations over the next 10 years are expected to more closely resemble those observed in recent years, rather than the lower correlations observed in the 1970s and 1980s. That said, the simulations indicate that the correlations between the U.S. and international equity markets are likely to decline from their currently elevated levels over the next 10 years as stock market volatility gradually wanes and the financial crisis eventually passes. Secular global economic developments that will alter interregional and intraregional trade patterns should also contribute to lower-than-present international equity correlations over the following decade. Among the expected developments are a reduced reliance on the U.S. consumer to drive the world's economy and a gradual shift in focus within emerging market economies from export-led growth to economic expansion fueled by internal consumption demand.

Commodity Prices And Emerging Markets

Over the past several years, commodity prices rose and fell dramatically with changes in the commodity demands of the BRIC economies, among other factors (see Figure 12).[5] These recent events have raised important questions about the sensitivity of emerging market economies and their stock markets to movements in commodity prices.

Figure 13 presents the average correlation of emerging and developed markets with changes in commodity prices, measured here as the total return on the S&P GSCI Commodity Total Return Index. Broadly speaking, emerging markets tend to correlate more positively with commodity prices than do developed markets (i.e., EAFE countries or the United States). This is not surprising, since emerging markets tend to be more commodity-intensive than developed markets and are generally net commodity exporters.

Perhaps more surprising is the fact that the average economic and financial correlation of emerging markets with commodity prices in Figure 13 is fairly low. Since 1988, the average monthly correlation between the GSCI Commodity Total Return Index and the stock market return on the MSCI Emerging Markets Index has been approximately 19%.

1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 |