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Tight-knit relationships that have defined the US equity market’s five-year bull-run are breaking down as investors look to a future with less monetary stimulus from central banks.
Equity market correlations, which measure the relationships between different stocks, have fallen to their lowest levels since the onset of the financial crisis, according to Barclays.
A study of the daily fluctuations between the 50 largest stocks on the S&P 500 over a rolling three-month period showed that the relationship between their movements reached its lowest mark since 2007 this week.
Correlations have been closely followed by investors since the crisis, as stock prices have tended to rise and fall in broad unison rather than diverge based on the merits of the individual companies.
The data suggest that investors seeking returns in 2014 will need to pay closer attention to specific company and industry trends rather than rely on broad market gains.
David Bianco, chief US equity strategist at Deutsche Bank, said: “Our discussions are turning more to industry specific topics. The debate is going from big picture topics like global economic growth to things like capital expenditure in specific sectors such as in technology and industrials.”
The multiyear low in correlations comes as investors prepare for further reductions in Federal Reserve monetary stimulus measures, which helped power a 30 per cent rally in US stock prices last year.
Already this year there has been a divergence in the returns from the different sectors of the S&P 500, which is flat so far. Healthcare stocks have scored the biggest gains among sectors on the benchmark and climbed 2.6 per cent, while telecom stocks are the weakest and have lost 2.7 per cent.
Oliver Pursche, portfolio manager at Gary Goldberg Financial Services, said: “If you look at the market returns of 2012 and 2013, the S&P 500 was a very strong performer and so were the various sectors. We don’t think the S&P 500 is going to do fantastically well but we do think healthcare, consumer discretionary and industrials will.”
A decline in correlated stock moves will be welcomed by active investment managers who have struggled to beat US equity benchmarks in recent years and seen sales of passive investment funds soar.
“Correlations have dropped to the point where individual stock picking talents will be visible again,” said Nicolas Colas, chief market strategist at Convergex. “This is very welcome because it signals the market is beginning to incorporate less Federal Reserve involvement, allowing investors to dedicate more capital to markets by giving them opportunities to manage risks through diversification.”
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