Nick Colas, chief market strategist at Convergex, on the “curse of the correlations” starting to wash away in the wake of the election – which is what active stock pickers and traders have been yearning for during the last 8 years or so:
We have tracked the “Curse of Correlation” on a monthly basis since October 2009. The basics are simple: the average sector (tech, financials, utilities, etc) correlation to the S&P 500 has been 82.3% since we started looking at the data. Other asset classes, such as Emerging Market and EAFE (Europe, Asia, Far East) developed economy equities have been in that same low-80% range. High yield corporate bonds have shown a 70% average correlation to equities. History, experience, and common sense tell us that all these correlations to U.S. stocks should be closer to 50%. Yes, they are all financial assets, but how much should tech stocks trade like junk debt or utilities? Not as much as they have.
Now, correlations have declined dramatically. We’ve included several charts and tables in the attachment to this note, but here is the highlight reel from the last month:
- Average sector correlations to the S&P 500 were 56.8% over the last month, the lowest reading since we started looking at the data in 2009. The prior low of 58.4% was in December 2014. Just 2 months ago, average correlations were 79% and last month they came in at 66%. The trend is clearly our friend here.
- Correlations between non-US equities and the S&P 500 were 77.5% for the developed economies of the EAFE countries and 51.6% for the Emerging Markets. Two months ago those readings were 88.4% and 87.8%, respectively.
- Domestic high yield corporate bonds showed a 54.75% correlation to the S&P 500 over the last month. That’s well below the long run average of 70% and the 87.8% of two months ago.
- Looking at the individual sectors, all show materially lower correlations to the market as a whole over the past month. Technology is down to a 70% correlation from 92.9% two months ago. Energy stocks are less than 50% (41.4%, to be exact) correlated to the S&P 500, versus 72.4% two months ago. Even the big winner of the last month – Financials – are now just 53.2% correlated to the U.S. equity market as a whole.
Josh here – okay active managers, this is your time to shine! Let’s see it.
Breaking the Correlation Curse, For Now
Convergex – December 8th 2016