Why do Assets Tend to Rise or Fall Together?

By Harvey Investment Management on August 3, 2020

Today’s question for our Ask the Advisor blog series is, “Why do all assets seem to move together when we have precipitous sell-offs?” In other words, why do the market segments tend to rise or fall together? What causes this? We’ve certainly seen evidence of this in the markets lately.

To answer this question, I need you to think about what happens when you have a downturn in the market. When people panic and sell their assets, all those assets tend to move together, and they tend to move down. This happens regardless of the type of assets. You could be holding stock, commodities, corporate bonds, or real estate that’s publicly traded, and all of a sudden, you look, and the stock markets are down 10%, your investment-grade bonds are down 10%, your municipal bond holdings are marked down 10%.

Why does this happen? When people panic, they call their advisor or their custodian and say, “I want out of the stock market. I don’t care what price I get for my assets, just sell. I want out now”. To make this happen, they typically have to try to find bids for these assets. Sometimes, these assets don’t trade every day all day like Treasury bills and stocks. In that case, they need to find somebody to buy this today to raise cash.” All those assets tend to move together in times of great stress. We call this “correlation.” So, the extent that things move together, they are correlated.

During standard market times, you typically have diverse assets. You may want to own airline stocks, for example, but not oil stocks. People tend to like diversifying their assets as they tend to move in opposite directions. However, with the pandemic, airline stocks got hammered as did cruise line and oil stocks. It wasn’t just one market segment; many of the major segments were hit hard. We also saw segments with preferred stocks, commodities, and other investments marked down precipitously. Remember, your investment statement will show a liquidation value if it’s available. Watching what is correlated (moving together) shows you where the real risk is. This is called “liquidity risk.” If you need to raise cash, how reliable do you think the values you see on your statement are? When everybody is selling, and nobody’s buying, that’s a period of extreme fear. When you have extreme fear, strange things tend to happen. In some cases, we’ve seen money market funds priced below a dollar. We saw this happen periodically in 2008. It was very rare, so the federal government stepped up and provided liquidity for those money market funds.

Recently, the government has stepped in again with the recent economic stimulus or “bailout” packages. So, now if somebody says, “I need a $100 million out of this money fund” (and that money fund may not have securities maturing for two or three days), they have options. They can go to the Federal Reserve and borrow that money to ensure that those assets are not marked down below a dollar. That’s called a “backstop.” However, it’s important to remember that when you see asset correlation, it doesn’t mean you need to sell all your investments. As we’ve discussed before, it’s not a good idea to let panic or emotions drive your decision-making. To learn some tips for feeling calmer while investing, watch “Four Ways to Stop Being an Emotional Investor”.

In addition to leveraging our experience to help build your legacy, we are also here to answer your financial questions. Please send an email to Harvey@RIAgroups.com so that we may answer your questions in a future blog or video post. If you prefer videos, we also have many videos to help demystify finance and the investing process on our YouTube channel.

About Harvey Investment Management, Inc.

Harvey Investment Management, Inc. provides information designed to help our clients achieve their financial goals. We aim to empower and support investors no matter where they are in their financial journey. Reading this blog may be the first step of many you take, and we encourage you to ask questions along the way. We invite you to learn more about our team and how we can help you reach your financial goals by emailing or calling us at 719.960.0969.

Brad Harvey, President, and CEO of Harvey Investment Management, Inc.