If Wall Street catches a serious cold over the months ahead, will the Australian sharemarket come down with pneumonia?

Wall Street certainly moves the ASX in the short-term. Its ups and downs are often replicated Down Under.

But in the longer-term, the picture is much more complex, as the accompanying graph shows.

Note, in particular, the ASX's impressive out performance in recent years and its greater resistance to US shocks.

Interestingly, studies show that the correlation between U.S. and foreign markets is highest when US shares are most volatile.

Past examples of this are the 1987 sharemarket crash, the mini-crash at the time of the 1990 Gulf War, and the 1997 US correction.

Thus, whenever the correlation coefficients are at the high point of their cycle, these are often the best times to be diversifying outside the US.

Why? Because in all likelihood the correlation coefficients will diminish, and the diversification benefits will rise over the subsequent months.

But what drives the Wall Street/Aussie equities relationship in the longer-term?

A good starting point are the major differences between the US and Australian economies. They include:

• our domestic market is much smaller, has far fewer economies of scale to help boost company earnings, and costs in most industries are higher;
• our banking companies match US performance but most other sectors do not; and
• our IT companies have mostly failed or have been taken over by overseas ones.

Until this decade, sharp slowdowns in the US economy - for example, in the early 1980s and early 1990s - were quickly mirrored Down Under.

But early this decade, the Australian economy did not follow the US economy into recession. Our growth had not been driven by the US "tech boom" of the late 1980s and our sharemarket did not suffer the rational exuberance which blew up the Wall Street bubble.

In more normal times though, the Australian economy is still affected greatly by what is happening in the US for three main reasons:

• the US is still the biggest consumer of most industrial commodities and ups and downs in its economy affect their world price;
• the US is the biggest consumer of Asia's manufactured exports. When US demand for such products changes, so too does the demand for the Australian minerals and energy they often contain; and
• many Australian companies have direct exposure to US economic ups and down through operations there and a number of large Australian companies are subsidiaries of US companies.

However, there are two key factors which make our sharemarket less likely to go into panic mode when, and if, Wall Street suffers a sustained and severe correction.

The first is the fact that our inflation, interest rates, and productivity are now much closer to the US rates than they were over the period 1985-2000.

This means that if the US and/or global economy slows markedly we will suffer less sharp cuts in capital inflows and in foreign interest in our shares than we did in the early 1990s and 1980s global slowdowns.

The second is that we are now more dependent on Asian markets and Asian demand for our key export commodities than we were even just a few years ago.

When commodity prices skyrocket, as they have in recent times, the ASX usually has its biggest climbs and the likely continuing strong growth of the Chinese economy will put an important floor under our economy and many of our commodity and resources shares.

Moreover, our floating $A helps absorb external shocks and the massive reductions in our public debt over the past decade have made foreign investors far less likely to desert Aussie equities when market clouds gather.

Indeed, the strength of the $A in recent times is an indicator that the rest of the world has a very different view of our economy than even a decade ago.

In short, the Australian economy has grown up over the past 20 years and is less susceptible to imported ills.

The immediate future?

Certainly, the higher a market goes, the closer it gets to the top.

The consensus amongst US and Australian analysts, however, is that both markets are unlikely to suffer severe, sustained corrections over the next few months.

But never forget that the big corrections are never predicted accurately by the fanciest modeller or most arrogant analyst - despite what they may claim after the event.

Dr David Clark taught Business Economics at the University of NSW for 35 years, was an AFR and Personal Investor columnist for over a decade, and is now an investor educator. The views expressed in this article are Dr Clark's not necessarily Vanguard's.