Decoupling

Decoupling

Decoupling is when one asset class starts behaving in a pattern that is different from its expected pattern. This behaviour is generally seen between oil and gas prices, which tend to increase or decrease together, but due to certain events their prices can move separately in case of decoupling. 

This is also something that is usually seen in gold and US dollar prices that are decoupled and tend to flow in the opposite direction from each other. 

What Is decoupling? 

In the world of finance, decoupling refers to prices or returns of an asset that begin to divert from the expected pattern. Hence, it is said to be decoupled. Decoupling happens when two asset classes that were behaving similarly begin to break their usual pattern at some point and starts showing signs of different behaviours. 

Understanding decoupling 

Understanding decoupling can be the key to saving your assets from bad investments. If one of your assets is coupled with another asset, you risk losing the value of both assets if the value of one falls. Investors use a measure called correlation to accurately calculate the relationship between two assets. How strong the correlation between two or more assets is, depends heavily on the metric range between -1 and +1. If the correlation between two or more assets turns out to be +1, then that means the two assets will follow the same pattern, but if that value is -1, then that indicates that the two assets will follow a pattern opposite of one other. This value allows investors to diversify their assets by investing in assets that are in no way correlated with one another. So, if the value of one asset decreases, the others won’t go down the same route. 

Decoupling of markets 

Economies and markets are not an exception to decoupling. One example would be the Great Recession that happened sometime in 2008. It originally started in the US but due to the coupled nature of the economy, but it soon started happening globally leading to a global recession. A coupled economy allows other economies to benefit when the one big economy, such as the US economy, benefits. But the opposite can also be true. Decoupling of markets and the economy can save them from the fall of the other. 

Importance of decoupling 

Decoupling plays an important role in the financial world and it can impact the following sectors. 

• Financial markets 

Decoupling can impact several financial markets, including stocks, bonds, indexes, and more. They could be correlated to each other now, but that may not always be the case. At some point, they will part ways and decouple from each other, whether it’s gold and US dollars; or the US economy and an emerging economy. 

• Environment and the economy 

The economy and the environment usually tends to go in opposite directions. Whenever there’s significant economic growth, the environment tends to suffer. For example, growth in the economy due to higher sales of fossil fuels comes at the cost of the environment. But that shouldn’t be the case and that’s what makes decoupling so important. Decoupling the growth and development of the economy from the environment will minimise its impact and influence on one another. 

Examples of decoupling 

The correlation between developed and emerging markets often experience decoupling. Usually, developed markets are in sync with emerging markets, but can be prone to decoupling. For example, sometime in late 2017, the emerging market starts gaining significant value as compared to its developed counterpart, showing signs of a break in pattern and decoupling, which continued till 2019. 

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