An important component for asset allocation decisions is the future correlation structure of equity returns. While others have found that correlations change through time, we explore the reasons why they change. We find that equity cross-correlations are related to the coherence between business cycles in the respective countries. Correlations are higher during recessions than during growth periods.
Correlations are low when the two business cycles are out of phase.
We also propose a semicorrelation metric which differentiates equity comovements in bull and bear markets. Finally, we present a method to forecast multiperiod equity correlations.