The news for stock pickers just keeps getting better — in addition to the overall great year for the market, one of the biggest trends holding back performance has shown a sharp turnaround.
Correlation, or the tendency of stocks to move up and down in lockstep, has hit a post-financial crisis low, according to DataTrek Research. That means active managers have more opportunity to find price discrepancies and post returns that beat the big indexes like the S&P 500 and Dow Jones industrial average.
“Lower correlations — regardless of why they exist — are fundamentally good,” DataTrek’s Nick Colas said in his daily note Wednesday. “They show active societal capital allocation finally at work again, and give active managers a better shot at outperforming if they pick the right groups. Markets are less volatile under this regime as well.”
Overall, the 11 sectors in the S&P 500 are showing just a 41 percent correlation with the broader index. Exclude technology and that number falls to 37 percent.
That’s off a number that was close to 100 percent at one point:
High correlations came about due to a number of factors, including aggressive central bank policy that kept volatility in check, the rise of passive index-based investing and the general aftershocks of the financial crisis that kept many investors at bay.
However, 2017 seems to have changed all that. In addition to the gain of about 14 percent in the S&P 500, active managers have shown their strongest performance in years against their benchmarks. Some 54 percent of large-cap managers have outperformed this year, according to Bank of America Merrill Lynch.
Colas cautioned that the trend could reverse, but said the general trend seems to look positive for managers trying to fight the old correlation battle.
“Given our constructive view on US stocks we naturally hope this trend will continue,” he said. “But even when markets hit a bump in the road (and they always do), lower correlations should act to absorb some of the damage.”
