Thursday, July 15, 2010

WSJ: Correlation Soars on S&P 500 Shares

Hmmm... this sounds *vaguely* familiar to a certain blog writer's complaints the past few years.  [Jun 30, 2009: Bloomberg - Correlation Among Asset Classes Highest Ever]  [Jun 29, 2010: Correlations Among Asset Classes Reach Ever Higher Extremes as HAL9000 Algos Dominate Life]  Instead of carbon based lemmings, we now are dominated by the silicon variety.  EFTs and HFTs - a great combo if you hate stock selection.

Via WSJ:
  • Stocks are trading in lock-step more than at any time since the 1987 crash, and the trend has some analysts concerned.  In recent weeks, stocks in the Standard & Poor's 500-stock index have shown an increasing tendency to move in the same direction at the same time. Last week, those stocks' tendency to move in the same direction as the index hit an extreme not seen since October 1987.
  • The market's flock-like behavior is one more reflection of the growing influence of investors using broad-based strategies to buy and sell large blocks of stocks. Instead of picking individual stocks to hold over a period of time, they trade in and out of the market using broad indexes. Often, these investors use exchange-traded funds, which trade as easily as a single stock but contain many different stocks that may belong to the S&P 500, the Nasdaq 100 or another index.
  • Heavy trading in exchange-traded funds means more stocks are likely to move in the same direction on any given day. Analysts call that correlation, a mathematical term meaning similarity of behavior. Correlation is on the rise, to the frustration of investors who are trying to analyze stocks based on their underlying strengths and weaknesses.  (amen brother
  • "It is an indexing market and not a market for stocks. On good days everything goes up, and on bad days everything goes down. Everyone talks about baskets or sectors," says Jeffrey Yale Rubin, research director at Birinyi Associates. "It is harder for individual investors and even for mutual-fund managers to distinguish themselves by doing individual stock picks. They might get the product right and the earnings right, but the market goes down and the stock is going to go down as well."  (student body left.... student body right)
  • Every day, Birinyi measures the 50-day average correlation between the direction of the S&P 500 and that of its member stocks. In this case, correlation is a measure of the degree to which one stock tracks the movement of the index. A correlation of 50% means half the index's component stocks are moving in the same direction as the index. A perfect correlation would be 100%, with all stocks tracking the index. The average correlation since 1980 has been 44%.
  • Last week it surpassed its 2008 high of 79% and hit 81%, the highest level since the 1987 crash, when it touched 83% for one day.
  • The tendency of stocks to rise and fall together may help explain why some conservative, dividend-paying stocks have been turning in disappointing results lately, while some riskier stocks, such as computer-chip makers, are holding up better than expected.
  • "Stocks aren't moving because of the sector they are in, but because the overall market is down" since late April, Mr. Rubin says.
  • Exchange-traded funds, high-tech trading strategies and quick shifts to cash permit investors to react quickly to market moves without analyzing individual stocks, but they also mean professional investors have less need to use traditional defensive stocks as havens.

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