What is Recoupling?
Recoupling is a market event or process that occurs when returns on asset classes revert back to their historical or traditional patterns of correlation after deviating for a period of time. This is in contrast to decoupling, which occurs when asset classes break away from their traditional correlations.
- Recoupling is the movement of asset returns or other economic variables back to their historical or theoretical correlation after a period of decoupling when the normal relationship breaks down temporarily.
- There are many correlations between the performance of various types of assets that can be driven by various economic or non-economic factors.
- After a change in economic conditions, temporary decoupling can occur followed by recoupling, but recoupling might not always happen based on the nature of the economic shift and related psychological factors.
The movements of different classes of assets relative to one another have exhibited patterns of correlation ground in academic theory as well as empirical evidence over time. At times, the correlations decouple, causing market observers to search for explanations. The decoupling period can be brief or long, but eventually asset class behavior will recouple to historical norms. Rarely, a relationship will break permanently. When this occurs it strongly suggests that an external factor not present in traditional models is now at work.
There are many sets of market correlations that are taken as a given. Some examples: rising bond yields mean a strengthening of the currency; rising interest rates cause equity markets to slow down in appreciation or even depreciate while falling interest rates support equity markets; strengthening of a currency of an export-dependent country leads to a fall in the stock market of that country; a climb in the price of oil and other global commodities accompany the weakening of the U.S. dollar.
These relationships might be simply driven by accounting or financial identities (such as the inverse correlation between bond prices and yields), in which case they virtually never decouple; by spurious statistical correlations, which can frequently decouple; or by causal economic relationships, which can be described by economic theory and will decouple or recouple in response to real structural changes in economic relations, changing economic incentives or preferences, or purely psychological factors.
Economists tend to focus on changes in economic conditions, incentives, and structural relations in their theories to explain decoupling and recoupling. After a major economic shock, advance in technology, or drastic shift in economic policy the economy often undergoes periods of adjustment when economic variables (including returns on various asset classes) adjust to the new conditions. This means they can decouple temporarily until the economy moves toward a new equilibrium and returns will tend to recouple. However, the new economic conditions might drive a new equilibrium in which the relationships between different economic variables is permanently changed so that there is no guarantee that any given correlation will re-emerge and recouple.
On the other hand, other economists such as Keynesians and behavioral economists argue that markets can behave irrationally, so it should not be a surprise when long-standing relationships—supported economic models or by many decades of consistent data that—break down for a period of time. They argue that psychological factors such as cognitive biases or arcane animal spirits might delay or even permanently prevent recoupling.
Decoupling is becoming more commonplace: even the Federal Reserve has been flummoxed once in a while by such a market "conundrum." (For example, Chairman Alan Greenspan was hard-pressed to explain the narrowing of short-term and long-term rates in the midst of the Fed interest rate hikes). However, recoupling is still expected to occur by academics and analysts who make a living out of predicting the behavior of markets even if they find it necessary to continually fine tune their models to stay current with market complexities.