Correlation Does Not Imply Causality

May 21, 2009

This is an interesting chart that I dredged out of an article by Mebane Faber reporting on a global asset allocation summit. At least during 2008, when the dollar fell, gold went up. (The dollar chart is inverted.) Or is it that when gold went up, the dollar fell? This type of chart can only ever show correlation—and correlation does not imply causality. Who knows what causes what? The problem is that many strategic asset allocation models are built with correlations. The models often assume that the correlations are stable, but experience has shown that they are not. (This is no less a problem for Modern Portfolio Theory.) Models that are built with correlations fail each time there is a regime change where the correlations shift or adjust to a “new” normal. Things that are impossible in finance textbooks happen all the time in real life.

Our Systematic Relative Strength models are not built this way. We look at the relative strength ranking of each item on its own merits. If gold is highly ranked in the Global Macro universe, for example, it would likely be in the portfolio. If the dollar is also highly ranked, it would happily coexist with gold until the rankings dictated that one of them was removed from the portfolio. Relative strength doesn’t make any assumptions about the asset correlations, and we think that is one of its strengths.

Correlation Does Not Imply Causality

Correlations

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What’s It Like to Work at Dorsey Wright Money Management?

May 21, 2009

My name is JP Lee, and I’m the youngest member of the team here at DWA Money Management.

John, Andy and Mike have dominated the serious posts so far. I won’t try to compete with them in the data analysis department; instead, I’ll bring a little humanity to the equation. Some soul, if you will. So here goes.

One of the first questions that you ask somebody when you get to know them is, “What do you do for a living?” Depending on who’s asking, I say a number of things.

I’m an assistant at a money management firm.

You know what stocks are, right? I work with stocks.

I work in Pasadena….in an office building.

I stuff envelopes for a living.

Once in a blue moon I’ll meet someone who follows the market or is an investor (I’m 25 years old, I don’t hang out in the Chairman’s Club). It’s always funny to me when people give me their opinions on this stock or that stock, or a brief rundown on what the economy “really” needs to get going again. Rants about corporate greed, the housing market and the next Great Depression, lifted straight out of Newsweek and Time. It’s fun to smile and nod along with market mavens.

At the end of the day, I wear a lot of hats. I answer the phone, send out new client welcome packets, reconcile monthly account statements, and help organize quarterly statements and billing. Every once in a while I might liquidate a new account’s holdings and get the cash ready to invest in the DWA strategy. There’s a lot going on in the office, and there’s only 5 people here. It’s fun and exciting.

As the only member of Generation Y in the office, I consider myself lucky to be here. Just today I saw a headline about college graduates in 2009 that showed that LESS THAN 20% of those who graduate this year will be employed. That’s a scary number.

Stuffing envelopes never sounded so fun. I love this job!

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