Is this is a good thing?
Maybe. Maybe not.
Yes, I’m familiar with the work of Hyman Minsky and his “Stability is Destabilizing” shtick. And I mostly agree with the premise. But who sets the stopwatch on something like that? There’s no formula to detect the moment this stability begins to actually destabilize, so…
In the meantime, let’s look at a very positive development that is endemic to a capital markets structure that is healing and normalizing right before our eyes – the breaking of hyper-correlation between asset classes and stock sectors. Nicholas Colas and his team at ConvergEx take a look at this phenomenon in an important note this morning:
- the average correlation of the 10 industries in the S&P 500 to the index itself was just 70.6% last month. That’s the second lowest reading since October 2009 and far better than the +95% levels of mid-2011.
- Industry sector correlations to the S&P 500 dropped last month to 70.6%, down from 79.3% in the prior month and 85.4% three months ago. Old timers who happen to be reading this will recall when 50% correlations were the norm in the 1980s and 1990s. We aren’t there yet, but we are more than half way down the road.
- High yield corporate bonds are finally floating free of their historical tethers to U.S. equities as well – correlations over the last month are down to 27.7% from 84.9% just three months ago.
- Equities from developed economies (we look at EAFE markets) do still correlate closely to U.S. stocks (82.5% last month), but emerging markets are down to 46.2% (from 78.7% three months ago).
Josh here – The reason this is such a positive sign is that it represents a return to rational thought amongst individual investors as opposed to the risk-on / risk-off game that so many were caught up in for so long. It also represents a refutation of the ol’ “The Fed’s driving dollars into everything indiscriminately” complaint.
As Nick explains, “A global capital market that remains linked only to central bank policy would be a useless system, even if it gains another 50-100%. Successful markets go up, and down, and side to side. It is their independence that creates their value. And defines their success.”
This is good news, something to be excited about for sure.
Nicholas Colas, chief market strategist at ConvergEx Group, a global brokerage company based in New York