One positive for stock pickers – and fundamental equity research providers – is that stocks are less likely to move in lock step than they were during the financial crisis, even though correlations remain higher than pre-crisis levels.
The CBOE S&P 500 Implied Correlation Index, which is based on the S&P 500’s top 50 companies, shows lower levels of correlations between stocks, ranging between 50 and 60 percent, down from nearly 90% during the peak of the crisis.
Nevertheless, correlation levels remain above the 40% correlation level in 2007 when the index was introduced. Investment strategists blame the tendency of stocks to move en masse on the high levels of monetary easing that central banks have maintained since the financial crisis. With the US Federal Reserve starting to raise rates, we can expect correlation levels to fall further.
High-correlation environments are bullish for economic research and bearish for fundamental stock research. Conversely, easing correlations signal waning central bank control over equity markets and are bearish for economic research and bullish for stock pickers.
More broadly, lower stock correlations help those institutional investors who pursue fundamental equity investment strategies – active equity managers in particular. However, rising investment in passive financial products which invest in broad based indices may mean that correlations never fully return to the levels seen a decade ago.