In mid-September of 2011, Colas at ConvergEx reported that U.S. sector ETFs were moving in lockstep to a degree not seen since the 2008 credit meltdown. Average correlations between the 10 major sectors of the S&P 500 zoomed to 97.2% from 82.1% three months earlier. [Sector ETF Correlations Highest Since Financial Crisis]
On Tuesday, the strategist proposed a potential “better mousetrap” than the VIX to measure market sentiment: correlations between S&P 500 sector ETFs and the index as a whole.
The VIX has been moving lower lately but sector ETF correlations have been rising. Even with Monday’s spike, the VIX is trading around 20, its long-term average.
“Conversely, the correlation data is sending up a very visible warning flare about future market direction. Back in February/March 2012, this indicator hit its low (good for stocks, since they are moving distinctly and separately) and began to trend higher (bad for stocks). Now, sector price correlations have essentially gotten back to their 2 years averages – 87/88%,” Colas wrote. “The real ‘Buy signal’ from sector correlations is when then hit 95%, some ways from here … this occurred in mid 2010 and Fall 2011 – both good times to buy U.S. stocks.”
However, there are asset classes that “aren’t clustering around stocks like scared sheep in a thunderstorm,” the strategist added. “Precious metals, for all their whippy action this past month, are fulfilling their promise to act independently of financial assets.”
Meanwhile, U.S. high yield bonds are “at the other end of the spectrum” and showing a high degree of correlation with domestic stocks. International equities – developed and emerging economies alike – are also moving in step with the S&P 500, Colas said.
