Examples of Current Major Market Clusters

I want to follow up and provide a bit more details to the excellent “A Visual of Current Major Market Clusters” post by David Varadi.

Let’s first load historical for the 10 major asset classes:

• Gold ( GLD )
• US Dollar ( UUP )
• S&P500 ( SPY )
• Nasdaq100 ( QQQ )
• Small Cap ( IWM )
• Emerging Markets ( EEM )
• International Equity ( EFA )
• Real Estate ( IYR )
• Oil ( USO )
• Treasurys ( TLT )

###############################################################################
# Load Systematic Investor Toolbox (SIT)
# http://systematicinvestor.wordpress.com/systematic-investor-toolbox/
###############################################################################
setInternet2(TRUE)
con = gzcon(url('http://www.systematicportfolio.com/sit.gz', 'rb'))
    source(con)
close(con)

	#*****************************************************************
	# Load historical data for ETFs
	#****************************************************************** 
	load.packages('quantmod')

	tickers = spl('GLD,UUP,SPY,QQQ,IWM,EEM,EFA,IYR,USO,TLT')

	data <- new.env()
	getSymbols(tickers, src = 'yahoo', from = '1900-01-01', env = data, auto.assign = T)
		for(i in ls(data)) data[[i]] = adjustOHLC(data[[i]], use.Adjusted=T)
		
	bt.prep(data, align='remove.na')

Next let’s use the historical returns over the past year to compute correlations between all asset classes and group assets into 4 clusters:

	#*****************************************************************
	# Create Clusters
	#****************************************************************** 
	# compute returns
	ret = data$prices / mlag(data$prices) - 1
		ret = na.omit(ret)		

	# setup period and method to compute correlations
	dates = '2012::2012'
	method = 'pearson'	# kendall, spearman
	
	correlation = cor(ret[dates], method = method)    
        dissimilarity = 1 - (correlation)
        distance = as.dist(dissimilarity)
        	
	# find 4 clusters      
	xy = cmdscale(distance)
	fit = kmeans(xy, 4, iter.max=100, nstart=100)
	
	#*****************************************************************
	# Create Plot
	#****************************************************************** 	
	load.packages('cluster')
	clusplot(xy, fit$cluster, color=TRUE, shade=TRUE, labels=3, lines=0, plotchar=F, 
		main = paste('Major Market Clusters over', dates), sub='')	

There are 4 clusters: TLT, GLD, UUP, and Equities / Oil / Real Estate. You can see assigned clusters by executing

	fit$cluster

This works quite well, but we have a number of things to explore:

• how to select number of clusters
• what correlation measure to use i.e. pearson, kendall, spearman
• what look back to use i.e. 1 month / 6 months / 1 year
• what frequency of data to use i.e daily / weekly / monthly

In the next post I will provide some ideas how to select number of clusters.

To view the complete source code for this example, please have a look at the bt.cluster.visual.test() function in bt.test.r at github.