S&P 500, Germany’s Dax, Back in the Same Groove (Up!)

By Ben Levisohn

On Jan 11, German and U.S. stocks were heading in opposite directions. The Standard & Poor’s-500 index had gained 1%, while Germany’s DAX had dropped 0.9%.

But a measure of the tendency of two indices to move in sync, known as correlation, was signaling that they wouldn’t go in separate directions for much longer. Normally, the S&P 500 and the DAX move in similar directions—the average 22-day correlation, a measure of short-term moves, between the two markets during the past 10 years is 84%. (A correlation of 100% means two indices move in lockstep all the time; a correlation of -100% means they move in perfect opposition.)

But the 22-day correlation, a measure of short-term moves, had dropped to negative 54% on Jan 11, the weakest since April 1995. And when correlations reach extreme levels relative to history, it’s usually just a matter of time before they reverses direction.

That’s exactly what happened during the past month or so. Since the DAX hit a 2011 low on Jan 10, it has gained 7.7%, while the S&P 500 has gained up 5.8%. Both indices are up 6.8% for the year. And the correlation between the two has also reasserted itself with a vengeance: It’s now 97%, the highest since Sept. 22.

So what’s changed? With the European Union taking steps to backstop its weakest members, investors are finally putting money to work on the continent.