Sector exchange traded funds moved as a herd over the past month as macroeconomic forces pushed and pulled the stock market. Rising ETF correlations suggest that the so-called risk on and risk off trades are ruling the day rather than bets on individual stocks or sectors, a market strategist said Tuesday.
Nicholas Colas at ConvergEx Group each month breaks down data on ETFs tracking sectors, precious metals, international stocks, currencies and bonds to determine their correlation against the U.S. stock market as measured by the S&P 500.
Inflamed Eurozone worries have knocked stocks down somewhat after they ended June and the first half of 2011 with a strong rally. However, sector correlations rose during the bounce, Colas said. In other words, the sector ETFs all went up together as industries traded in “virtual lock-step” with the S&P 500 as a whole over the past month.
“That’s unusual for U.S. equity markets, which have tended towards lower correlations in rising markest and clustered returns when things get ugly,” the ConvergEx strategist wrote in a note Tuesday, adding the average price correlation of the 10 major sectors as tracked by their ETFs rose to 89% last month, the highest level since late 2010.
“Since lower correlations are a necessary sign of healthy markets, this puts the end-of-second-quarter rally on the Greek debt ‘resolution’ in serious doubt,” he said.
The recent pattern contrasts with the trading action earlier in 2011 when it felt like investment managers were growing “more selective” in their stock and sector picks.
ETF correlations spiked during the financial crisis as investors stampeded from riskier assets and into safe havens such as the dollar and U.S. Treasury bonds. Correlations remained elevated as the market bottomed in 2009 and rallied in 2010, Colas said.
When sectors started to take their own separate paths earlier this year “it gave the feeling of a properly functioning capital market rather than one juiced or punished exclusively by macro concerns,” the strategist wrote.
Now, the market is being buffeted by the Eurozone debt crisis, the U.S. debt ceiling and speculation on the Federal Reserve’s next possible moves. [Gold ETFs Near Record on Debt Woes]
“That’s not to say this will make for a tougher market, as late June proves,” Colas said. “It does, however, make the decision about asset allocation more important than sector or stock selection.”
SPDR S&P 500 ETF (NYSEArca: SPY)
