Decoupling

Decoupling is the movement of different asset classes changing together in opposite directions. For example, one is rising and the other is falling. Basically, a decoupling in the financial market is a deviation of one asset class profitability from the expected or normal model.

For example, oil and gas prices usually change together in about the same way. They rise and fall together. The decoupling would be the fall of oil and the rise of gas in the same time interval.

Understanding Decoupling

Investors and portfolio managers track the correlation index. It helps to determine the correlation between two or more assets. The range of the correlation coefficient is from -1 to +1. The higher the correlation coefficient, the more accurate the synchronization between the compared investments.

A negative correlation coefficient indicates differently directed asset movements, while a positive correlation coefficient indicates assets moving in the same direction. When the correlation between assets is determined, investors and portfolio managers can distribute investments that move in different directions with each other. In this way, portfolios are diversified and if the value of one asset falls, the value of the other asset is unaffected by it.

Stocks of companies in the same industry are more likely to rise or fall together. They have a high positive correlation and change about the same.

On the other hand, decoupling indicates a mismatch in price movements of related investments or goods. For example, share prices of mining companies are quite closely correlated with precious metal prices. If some provocative news is published, precious metal prices could fall and mining stocks could rise. In this case, mining companies decouple from the price of gold, which means that the correlation decreases.

Decoupling of markets

Decoupling can also occur in markets that are moving in the same direction. Any economy that moves in the opposite direction from the basic trajectory of all other economies becomes a decoupled economy or market. The U.S. financial crisis that began in 2008 ended up affecting most global economies, resulting in a global recession.

An example of economic decoupling, also, is the independence of global developing markets on the demand in the U.S. to ensure economic growth after the recession. Thus, according to many analysts, the developing markets of China, Russia, India and Brazil previously were dependent on the U.S. economy. Now, they have become independent large markets for goods and services. These countries will be able to withstand it if the U.S. economy weakens. Nearly 70% of China's foreign direct investment (FDI) comes from other developing Asian countries. In addition, China invests a lot of money in commodity producers on its continent.

A country can withstand a global recession if it maintains a current account surplus and has foreign exchange reserves. These factors will provide the country with the ability to implement a stimulative fiscal policy that will decouple it from advanced economies.

Decoupling vs. Recoupling

Decoupling is a decrease in the correlation between two assets or markets. Recoupling is the opposite of decoupling, i.e., an increase in the correlation. A recoupling usually occurs after a short-term decoupling. In addition, technological innovation can affect the dependence of factors on each other.

In the energy sector, the 2 fuels have a great importance for many industries. The fields of crude oil and natural gas are interconnected. Changes in Henry Hub natural gas and West Texas Intermediate (WTI) crude oil prices between 1997 and 2009 were highly correlated with little deviation.

Then the correlation between their prices began to decrease. The reason was technological innovations, which led to a significant increase in the supply of gas on the market.

In the aftermath, crude oil prices increased rapidly, while natural gas prices kept a low level. It only began to rise in 2015. At that time, crude oil prices dropped. Crude oil and natural gas prices are now below 2009 levels, but the correlation between both of them has begun to increase.

Special Considerations

Decoupling can happen not only in the economic sphere, but also in the education, health, and human development fields. Environmental economists have a goal. They want to fence off the environment from damage due to industrial activities. In essence, they pursue the separation of industrial activities from environmental pressures.

According to economists, there are degrees of decoupling. They depend on the correlation coefficient. It means that the lower the correlation, the greater the decoupling. If the correlation between the two variables approaches zero or becomes negative, there is absolute decoupling. In other words, the two variables stop moving in the same direction. If the correlation between the two variables is still positive (but low), then it is a relative (partial) decoupling.

Conclusion

The market economy is complex. It consists of many parts. Some of them move in one direction, and some of them don't. The relationship between economic indicators, stock prices, and other characteristics of the world economy are constantly changing. Decoupling helps to describe these relationships.