Decoupling

What is Decoupling?

When the returning of an asset class gets diverged from the normal or expected pattern of correlation with others is known as decoupling. In simple words, the situation of decoupling takes place when varying asset classes that generally increase and decrease together start moving in opposite directions.

Oil and natural gas prices turn out to be good examples of it. Typically, both of them increase and decrease together. However, if oil prices increase and natural gas price decrease or vice versa, it will be a situation of decoupling.

Explaining Decoupling

Talking from the investment point of view, Portfolio managers and investors generally use a statistical measure, which is known as correlation. It helps to comprehend the relationship between two or more assets.

The correlation’s strength between two assets is based on where the metric will be falling within -1 to +1 Range. Here, if it falls on the higher number, it will represent substantial sync between the investments that are being compared and vice versa.

If it denotes the correlation of -1, it implies that the asset is moving in the opposite direction and the +1 means that both the assets are in the same direction. By figuring out such assets that are correlated, investors and portfolio managers get to generate a diversified portfolio by allocating such investments that are not correlated.

In such a situation, if one asset’s value decreases, the other investments available in the portfolio will not be following the same path. However, when a group of extremely correlated commodities or investments diverge from correlative attributes, the execution of decoupling is done.

For instance, if some negative information regarding diamonds is causing mining companies to increase the value, these companies would be decoupled from their diamond prices.

Decoupling of Economies

Not just assets and investments, even economies and markets, that used to move together once can be decoupled. One of the major examples of this situation is the financial crisis that hit the US Economy in 2008.

Eventually, it spread across other markets in the world, which led to a global Recession. Since markets were coupled with the Economic Growth of the US, any Market that moved in the opposite direction is known as the decoupled economy or market.