Stock correlations refer to the connection or relationship between the prices of different stocks in the stock market. When two or more stocks have a high correlation, it means that they tend to move in a similar direction. On the other hand, stocks with low or negative correlation may move differently from each other. It helps investors understand how different stocks may behave together, enabling them to diversify their investments and manage risks.
Full definition
From our perspective, picking the «right» stocks has the potential to contribute more to investment performance in environments of
low stock correlations than high correlation periods.
The more recent data suggest that the ongoing rise of passive investing is not a primary cause
of stock correlation changes seen over the last 5 to 6 years.
It appears that volatility wasn't the only number that was suppressed in the stock market last year:
Stock correlations also remained low.
Consequently, it appears that some of the long - term trends towards
high stock correlations are starting to breakdown, at least between some stock types.
Recent changes
in stock correlations — With one exception, all of the above correlation analyses run from no earlier than 1965 to no later than 2015.
Consequently, I took a closer look at the recent history
of stock correlations to see if some long - term trends appear to be changing.
Beyond that, low
stock correlation signals a stock picker's market — more specifically, one needs to choose the right sector to generate alpha.
Nevertheless, during the following years, when
stock correlations reverted to normal, the equal portfolio outperformed the value portfolio.
Simply put,
stock correlations measure the contemporaneous movement among stocks and explain why stocks move in different directions.
This is a particularly important point today
as stock correlations have fallen to their pre-crisis level, suggesting a greater benefit to diversification.
The proportion of passive investing continues to increase and
yet stock correlations appear to be uniformly decreasing.
The decline in the market appears to have coincided with the publishing and circulation of a research note from JP Morgan strategist Marko Kolanovic, who among other things noted that the recent decline
in stock correlations we've seen mirrors action investors saw before big sell - offs in 1994 and 2001.
We notice that value outperformed equal rather well during the tech - bubble period,
when stock correlations were relatively low due to the crowded trade in the Technology sector.
It remains to be seen whether a combination of the expected
low stock correlations in the market and a high active share of these funds leads to their significant outperformance in 2017.
More broadly, Goldman's data shows that the average three - month S&P 500
stock correlations have increased from just 9 percent in January to 52 percent today, or the fastest and largest increase aside from 1987.
Stock correlations are particularly important statistics for portfolio weighting, while weighting is important for portfolio returns.
With record - low volatility and low
stock correlations, some are proclaiming the return to favor of active management after years of suffering outflows to passively run index funds.
Stock Correlations Have Been Lower Overall, Creating Divergence and Opportunity S&P 500 Index stock correlations (January 1991 to February 2018)
Stock correlations — despite a recent spike — have been at multiyear lows, leading to what some have dubbed a «stock picker's market.»
Stock markets are not as attractively priced anymore and volatility is very low, while stock - to -
stock correlation is coming down from elevated levels.
However, in 2017 I started to come across news articles reporting that
stock correlations have recently and substantially declined.
Quinn and Voth present this graph of global
stock correlations over the last 100 years, which aggregates overall stock correlations among 120 different countries.
I've come across several news articles recently, for example here and here, indicating that
stock correlations are decreasing substantially.
Stock correlations — Can we validate the proposition that stock diversification decreases stock portfolio volatility and risk?
As I presented in Article 7.1 and evidenced by the 2008 crash,
stock correlations have increased conspicuously in the last 20 to 30 years.
The correlation in this case was between the rise of passive investing and the rise in
stock correlations themselves.
Having some amount of diversification helps buffer our portfolios against unpredictable changes in
stock correlations, the economy, markets, and world events, up to a point.