From the outside, a rally is a rally and upside is to be enjoyed by all but those that insist on going against the trend. However, a deeper look should turn up a rally based on falling sector correlations and that is not the current state of affairs with U.S. equities.
“The average correlation for the 10 sectors of the S&P 500 was 87.1% over the last 30 days, up from 69.9% three months ago and 81.9% last month. Other asset classes precious metals, fixed income, and currencies remain closer to their near term norms. Non-U.S. equities, however, are chained to the same oar as domestic stocks, with significantly higher correlations than three months ago, especially for EAFE developed market equities. Our take: the current rally in U.S. stocks is of distinctly lower quality than previous moves higher. Healthy markets have falling/lower correlations than currently on offer,” said CovergEx Group Chief Market Strategist Nick Colas in a note out Tuesday.
Colas notes that three months ago, when sector correlations were hovering just under 70%, the number appeared ready to revert to the long-term average of 50%-60%. That reversion has not played out.
Additionally, global stocks have been sticky with their U.S. counterparts. “The correlation between the S&P 500 and the EAFE (Europe, Asia, Far East) Index was up to 86.9% last month, from 75.7% three months ago,” writes Colas. Translation: The SPDR S&P 500 (NYSEArca: SPY) and the iShares MSCI EAFE ETF (NYSEArca: EFA) have practically been joined at the hip. [Chart of the Day: Developed Markets]
“Oddly, this spike in correlations is relatively unique to equity assets. Precious metals gold and silver show just 15.7% and 11.2% correlations to the S&P 500 this month. Those observations are very much inline with the last few months,” said Colas.
ConvergEx data indicate that over the past month, eight of the 10 S&P 500 sectors have correlations of 85% or more to the benchmark index. Energy and utilities are the exceptions. Over that time, the Energy Select Sector SPDR (NYSEArca: XLE) is up almost 3% while the Utilities Select Sector SPDR (NYSEArca: XLU) is higher by 2%. [Sector SPDRs Reign Despite Increased Competition]