Tuesday, June 29, 2010

Correlations Among Asset Classes Reach Ever Higher Extremes as HAL9000 Algos Dominate Life

On an anecdotal basis I began noticicing 3 years ago how increasingly asset classes have begun moving together in monolithic nature; I attributed this to the growing dominance of ETF trading (which has surpassed usage of individual equities for much of the 'fast money institutional' crowd) along with HAL9000 and his merry band of brothers, all programmed by the same type of PhDs data mining the same fact sets.  At the time I called it "student body left" trading, and it seemingly has only increased each year since.  Now people call it "risk on" or "risk off" ... whatever the case, it has become a bipolar market where there is no memory from day to day and that entire day is traded off the news of that specific morning... but can be forgotten by tomorrow.  We used to be a market influenced by lemmings, but now they run the market.  Remember 2 weeks ago?  Every asset up... get out of the way.  Risk is ON!  5 weeks ago?  You own stuff? Loser!  Risk is OFF!  Etc. 12 weeks ago?  Everything must go up!  Last week? Sell sell sell - everything!

Last summer Bloomberg noted this with actual data [Jun 30, 2009: Bloomberg - Correlation Among Asset Classes Highest Ever] and today has a follow up story as the trend is only increasing.   Wax on! Wax off! Student body left! Student body right!  Individual stock or asset selection?  So old school and out of fashion.  Today is as good as any other day to highlight this as it is yet another 90% day, at least the 15th since late April. (I believe we've had ten 90% down days, and five 90% up days since)
  • The Standard & Poor’s 500 Index and 10-year Treasury rates posted a correlation coefficient of 0.8412 in the 60 trading days through June 16, showing stock prices and bond yields were the most linked in Bloomberg data going back to 1962.
  • Rising correlations show investors are ignoring relative values among industries and assets and reacting to day-to-day signals on the economy, (amen) convinced Europe’s debt crisis will spur the second global contraction in three years.
  • Equities are also moving in lockstep with each other and assets tied to economic growth. The correlation coefficient between the S&P 500 and the Thomson Reuters/Jefferies CRB Index of 19 raw materials has been above 0.5 since April 13 and climbed to 0.77 on May 14, the highest since at least 1956, data compiled by Bloomberg using 30 days of trading show.
  • Almost 80% of swings in stocks within the S&P 500 are related to movements in the broader market, according to London-based Barclays Plc.
Let's stop for a moment and absorb that last nugget.  I've written in countless pieces in 2008 and 2009 that the reason I focus SO MUCH on the S&P 500 chart is the market movement now caters for 70% of the movement in stocks.  I guess I was underweighting it... more like 80%.  That is astounding.  Effectively this means whatever the underlying fundamentals of the company (or commodity!) almost all that matters each day is which direction the market moves.
  • “Correlation is one of the great lessons of the whole crisis, and it hasn’t let its grip on the markets go,” said Barry Knapp, the New York-based head of U.S. equity strategy for Barclays. Knapp estimates the S&P 500 will climb 13 percent to end the year at 1,210. “Whatever the nature of the crisis, the one decision investors seem to make is whether they should be in risky assets or out.”   (risk on! risk off!)
  • “Investors are very worried about which direction the global economy is going to take,” said Bart Zeldenrust, senior fund manager at Rotterdam-based Robeco Group, which oversees about $167 billion. “Correlation was very high during the financial crisis because there was only one bet that you could make in your portfolio: risk is on or risk is off. And it’s still very much so. It’s not a good sign.”   (well there you go, he literally says it)
  • The lockstep moves are hurting strategies designed to smooth out fluctuations across equities, industries and assets. Standard deviation, a measure of the variation in returns, for mutual funds investing in the biggest U.S. companies that have an average value similar to the S&P 500 fell to 5.8 percent in the first quarter, based on data compiled by Lipper & Co. and Bloomberg. That’s the lowest level in three years.
  • It’s been impossible for stock pickers lately,” Savita Subramanian, quantitative strategist at Bank of America Corp. in New York. “It’s been less about stock selection, less about fundamentals or company management, and it’s been all about macro.”

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