The

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Cluster Analysis of Financial Markets and Economy


What follows, should you dare to proceed, is a hierarchical cluster analysis of the financial markets and U.S. economy.


The graph, or dendrogram, below shows the similarity (or dissimilarity) between a ton of various financial market and economic indicators.  The indicators are given along the right hand side while the scale along the bottom is the measure of similarity between the various indicators, or factors.  The bar where two factors split is the measure of how close, or similar, the two indicators are.


As an example of how to read the dendogram, take the New Zealand Dollar, NZD, and Australian Dollar, or AUD.  Starting about the 3rd position down, the AUD and NZD cluster together.  This can be interpreted as the AUD and NZD behave similarly, or there is an association between them.


This dendrogram is interesting for two reasons: 1) It's comprehensive and 2) There are some very interesting associations between some indicators.  Below the chart, I point out some of the interesting clusters.


Click Here for the Legend

heirarchical cluster of U.S. economy and financial markets

Click Here for the Legend

Technique


The key to producing the clusters is first finding the similarity between the various indicators (also called factors or series).  The similarities are found using dynamic time warping, a technique that "stretches" or "compresses" the various time series to find how well they fit together.  Dynamic time warping accounts for leads, lags or dragging between similar factors.


Notes


In the dendrogram above, you may notice some of the indicators, or factors, have nothing to do with the financial markets or economics.  Some of the factors are environmental or climate related, such as global temperatures.  It cannot be dimissed that human activity is influenced by the climate around them.


Interesting Findings


1) As pointed out above, the NZD and AUD cluster together.  The interesting finding is they also cluster with the SOI, or Southern Oscillator.


2) The price of gold clusters with the Chinese yuan.


3) The Singapore Straits Times and Hang Seng stock indexes are together.  However, they also cluster with the U.K. FTSE and French CAC.  It's also interesting the FTSE and CAC do not cluster with the German DAX.


4) The yearly growth rate of the S&P 500 (dSP500) clusters with the slope of the U.S. treasury yield curve (Tslope).


If you dig into the details of the analysis above, you might be able to find your own interesting findings.  For instance, look at the Euro (EUR, about a third of way down).

Kyle Atkinson, Financial Forecast Center.