I’m sure it won’t surprise many value investors that stock correlations are at an all time high. It’s not like value investors need even more challenges thrown in their face. There were two posts late last week that showed data on this rise in correlations. Lets take a look.
First, Birinyi Associates had the following chart posted on their blog .
The chart shows that the last time correlations were this was during the 1987 stock market crash and the trend is definitely up. Next, there was a post by Felix Salmon of Bloomberg on the same topic. The chart from his post is below. It uses a different methodology than the above chart but the conclusion is the same. Correlations are at an all time high.
And I have to agree with Salmon’s conclusion on this topic.
The big thesis of the report was that correlations had overshot, and were likely to come back down; that didn’t happen. Instead, the trend has only continued since then: correlations have been increasing for a good 20 years at this point, and are now at levels exceeding those seen even in the aftermath of the 1987 crash, when portfolio insurance products forced high correlations on the market as a whole.
There are many reasons why correlations are high and rising. The rise of high-frequency trading is one; the rise of ETFs is another. Both of those are here to stay.
At least until (and a big IF) high frequency trading or the rise of ETF trading ebbs. I don’t see that happening any time soon.
All this means that the standard diversification mantra doesn’t work as well anymore. It also means that during times of high volatility, high correlations, means indiscriminate selling, tossing out the good with the bad. This can only make it harder for investors to stick with their investment plans. For a few, the true emotionally hardcore investors, this can also be a boon presenting all sorts of opportunities. But those are few and far between. I also thinks this makes a strong case for holding more cash than would usually be advised in order to take advantage of the opportunities presented by high correlations and high volatility.