Sector exchange traded funds are moving as a pack as the “risk on” and “risk off” trades dominate the market action with investors still concerned about global debt issues and the strength of the economic recovery.
“The market’s recent volatility has pushed asset price correlations for a variety of investment classes to levels we haven’t seen in over two years,” says Nicholas Colas, chief market strategist at ConvergEx Group.
“For example, the 10 different industry sectors of the S&P 500 show a 96.7% correlation over the last month, as compared to 86.5% for the last two years and a low of 72.4% in February 2011. High yield bond prices are at a 95.3% correlation to stocks, another multiyear record,” Colas wrote in a recent report.
The strategist tracks the correlation of various ETFs versus the S&P 500 to get a sense of risk in markets. High correlations are not indicative of a healthy or normal market.
Correlations had spiked last month as differences between individual stocks and sectors were blurred by the escalating debt crisis in Europe. [Sector ETF Correlations Jump]
Markets moving as a herd has confounded attempts to diversify portfolios by spreading money around in various sectors.
Asset prices “are currently moving in concert to a degree I have not seen in the two years we’ve been looking at the issue of price correlations,” Colas said.
“That’s simply not the way the classic market ‘playbook’ says stocks should trade. Early cycle stocks (financials, consumer durables) should not go up and down in tandem with defensive sectors (pharma, consumer staples), for example. And yet they very much do at the moment,” the strategist wrote.
Meanwhile, the high correlation between high-yield bonds and U.S. stocks shows junk bonds are “essentially acting entirely like stock and nothing like bonds.”
Colas blamed the high correlations on worries over the Eurozone sovereign crisis and the U.S. federal debt limit debate.
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