One of the manifestations of panic in the financial markets is indiscriminate selling.
This is measured by the asset correlations, or the degree to which the prices of two assets move in the same direction. When correlations go up as prices are tanking, it means people are just dumping everything with little regard to the asset-specific fundamentals. It’s something that’s been observed repeatedly during past financial crises.
“High volatility goes hand in hand with higher correlation — stocks move together,” UBS’s Julian Emanuel wrote on Tuesday. “China and the Fed have once again changed the emphasis from Alpha to Beta.” (Alpha measures the degree to which you can generate an excess return. Beta is the degree to which a stock moves with the market as a whole.)
According to Morgan Stanley’s Andrew Sheets, the correlation between stock prices hit a 15-year high on the day we saw the we saw the Dow crash 1,089 and the S&P 500 closed down 3.9%. People were dumping everything.
“Realised correlations rose significantly in August, particularly for mid and large caps,” Credit Suisse’s Lori Calvasina wrote. “Relative to other industry groups, realised correlations are high in Banks, Real Estate, Autos, small cap Energy and small cap Utilities and low in Food Beverage & Tobacco.”
But as they say, out of crisis comes opportunity.
“In the short run, high correlations indicate that global equities are due a bounce,” Citi’s Robert Buckland said in an August 27 note to clients. “Citi strategists think that it is too early to call the end of this 6 year bull market … As a team we would recommend that investors buy into this dip, but don’t chase any subsequent rally too far. “
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