Fat Pugs & Negative Correlation

In case you didn’t get the memo, the stock market took a hit today: the S&P 500 posted a loss of 1.38%. For those long-term investors – which should be everyone – this isn’t important in the big scheme of things. However, it did present a wonderful learning opportunity.

Today was a great example of negative correlation. What in the is world is negative correlation? Consider today’s stock market performance: While the S&P 500 was down, long-term United States Treasuries were up. And that is exactly what negative correlation is. Negative correlation means that when one thing goes one way, another thing goes in the exact opposite direction. 

Consider a non-finance example. Imagine doing a pull-up with an empty backpack. You can probably do a few on your own. Now imagine that I took an extremely fat pug and placed it that backpack. You certainly could not do as many pull-ups with that fat baby along for the ride. Now imagine adding another fat pug to the backpack. Now, you muster even less pull-ups before the weight of the fat pugs brings you a stand still.

The number of fat pugs in your backpack and that amount of pull-ups you can do is negatively correlated. As the number of fat pugs increases, the number of pull-ups performed decreases.

This is the same relationship between corporate stocks and long-term United States Treasuries. As one goes down in value (depreciates), the other goes up in value (appreciates), and vice versa.

In future posts, we will discuss why negative correlation is so awesome – and how to take advantage of it.