The markets and exchange traded funds (ETFs) moved in unison during the financial crash and when the markets began to recover, but if you’re looking to diversify, you may be relieved to know that asset correlations are – at last – beginning to drop.
ConvergEx Group’s Chief Market Strategist Nicholas Colas points out that the correlation between ETFs in the various financial market asset classes has diminished, which could indicate a positive sign that the financial markets are recovering, writes Olivier Ludwig for IndexUniverse.
In a sampling of 19 market-, sector- and asset-type ETFs, ConvergEx concluded that the correlation of returns for industry sectors, precious metals, fixed-income and currencies are all hitting a 12-month low. That’s great news for investors; the lower the correlations, the less sectors are moving in tandem, giving you more opportunities to play trends.
The data shows that we are returning to a healthier market environment where investors may use different assets to diversify and reduce overall risk as correlations diminish. “This move lower for correlations is a long-awaited piece of good news for fundamentally-oriented, bottom-up money managers,” remarks Colas.
Additional findings include:
- Industry sector correlations to the S&P 500 averaged 72.4% in January, a 16-month low. However, consumer staples stocks’ correlation to the S&P 500 decreased to 41% from 80% in December.
- Gold and silver continue to trade at a modest negative correlation to financial assets.
- The Australian dollar and the euro correlations fell to around 0% to 20% from over 60% in the fourth quarter.
- Corporate bonds also diminished in overall correlation. High-yield bonds have a 62%, whereas high-grade corporate bonds have a 15% correlation.
Despite the drop in correlation among industrial sectors and major indexes, the CBOE Volatility Index, or VIX, a.k.a the “fear gauge,” still stands at around 17, above its one-year low of 15, to the relief of options traders. Unfortunately, it seems as though it hasn’t been great for the ProShares VIX Short-Term Futures (NYSEArca: VIXY), which is down 6.2% in the last 10 days.
Lower correlations means we’re seeing more opportunities now than we have in months, so dust of your entry strategy and start looking for your spots by using the 200-day moving average.
Read the disclaimer; Tom Lydon is a board member of Rydex|SGI.
Max Chen contributed to this article.