Out-of-sync U.S. stocks hide market risks
U.S. stocks' tendency to move in sync has plunged to near-record lows, but what might seem like a stock picker's dream may actually be a mirage, and investors may be in for a rude awakening. S&P 500 correlation — a gauge of herd behavior, which measures how closely daily returns of index constituents align over a month — slipped to 0.22 at the end of June, close to the lowest since November 2021, according to data from S&P Dow Jones Indices.
That means that many stocks are moving in different directions. Investors expect stocks to move increasingly out of sync as shown by the Cboe 3-Month Implied Correlation Index, which measures the 3-month expected average correlation across the top 50 value-weighted S&P 500 stocks. The Index touched a record low of 17.59 on Wednesday.
That would typically lower risk and offer more opportunities for stock pickers. But with the bulk of the market's gains being driven by a handful of mega cap names and a crowd of market bets on continued low correlation, investors may be relying on a false sense of calm. «The risk metrics that look quiescent and favoring idiosyncrasy may in fact be a chimera much more vulnerable to a macro shock than implied currently,» said Arnim Holzer, global macro strategist at EAB Investment Group.
History suggests such narrow breadth can set the market up for a sudden surge of volatility. «From these low levels of stock correlations, equity volatility has historically risen,» UBS strategists said in a note on Wednesday. The Cboe Volatility Index, the so-called Wall Street 'fear gauge,' which recently closed at it lowest in nearly 3-1/2 years, has generally jumped by 10 points over the coming quarter when 1-year stock correlations have been at the current low
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