Currencies Are Risk Off, Equities Are Risk On: A Divergence In Past Asset Performance

Last couple of days show asset classes acting in divergence from past market movement. Since summer of 2012, euro and S&P have traded almost in lock step….providing indications of sentiment. Trading in opposite correlation are U.S. dollars. Such positive euro and S&P correlations and its inverse, U.S. dollar, have not been numerically precise, but have moved with convincing consistency. These three assets have been so consistent; they’ve been market prophets due to all three moving in expected correlation.

Recently, the currency component of these three assets move according to last several months of history. Being when dollar goes up, euros go down. However, and also recently, equities aren't moving according to several months of predictability. S&P and Dow are moving up. Given dollar and euro currency movements, one would expect equities, or S&P and Dow, to go down. But they haven’t, in fact equities are increasing in value.

Equities are breaking from past correlation and rising from side way movement. Still, currencies trade according to months of performance. Currencies are seriously risk off with dollar up and euro down in notable terms. But equities assert a serious risk on look, by going up. Therein resides divergence in currency and equity assets. Equities are now outperforming past correlations with currencies. Why.... is the question now.

Currencies are tied to fundamental country performance….essentially a country’s economic indicators and domestic ability to show wealth…as in consumption, inflation and debt. Equities are tied to  fundamental capacity of companies to increase revenue firstly. Depending on ability of management, revenues are theoretically converted into earnings, boosting shareholder value.

Looking at recent movement in equities against currencies, such divergence doesn't appear to be justified by fundamentals . That is, equity markets or company earnings and revenues don't look that much better versus issues countries are confronting. Conversely, equity markets might be seeing optimism in coming country or company performance. 

Reason for optimism seems remarkably clouded now. Clouds right now come especially from prospects of fiscal solutions in the U.S., and whether the Federal Reserve will expand QE3. 

Fundamentals for both currencies and equities remain challenged after economic indicators and company earnings reports are considered.