Photo: Brett Schaerer
Ever since the financial crisis, all of the big themes in markets have all been macro oriented: Currencies, central bank moves, interest rates, global trade, sovereign credit risk, and so forth.In this environment, there’s been a remarkable consistency in how things trade. Risk on: Stocks, commodities, the Australian dollar go up. Risk off: Treasuries and the Japanese yen rally. That’s been it.
As 2012 closes out, there’s evidence that the age of macro may be coming to an end for now.
In BofA’s “Contrarian thoughts” for 2012, Chief Investment Strategist Michael Hartnett writes:
One of the biggest surprises this year was the bear market in volatility. Massive liquidity programs from global central banks trumped tail risks. A rise in volatility next year would not be a surprise, particularly in the FX market. With policy rates around the world close to zero, the new automatic stabilizer is FX. But perhaps the biggest surprise in 2013 and beyond is that the era of tail risks is coming to an end. Note that the pair-wise correlations of all S&P 500 stock combinations has fallen to 30%, down from a high of 70% in 2011. This indicates that we are close to being in a differentiated/stock picker’s market.
As the chart shows, the S&P is getting close to territory that can be characterised as a “stock-picker’s market”, whereby it pays to be a good stock selector, rather than knowing whether it’s Risk On/Risk Off.
Mark Dow made a similar observation in his end-of-year assessment of markets:
First, it really is a stock-pickers’ market. It’s a phrase I don’t like because it is overused by guys on TV who want to sell you there stock-picking services. Somewhat fitting I guess that just as everyone scrambles to go macro, stock picking seems to be working. On what basis do I say this? Look at the index of implied correlation of the elements of the S&P, to start with.
The implied correlation amongst S&P components has been heading downward all year. In case you can’t make it out, it falls from just above 80 per cent last January to just below 65 per cent in December. This tends to be both a bullish sign as well as an indication of less ‘macro’ and more ‘stock picking’.
Second, we have seen of late many of the crowded positions underperforming and many of the hated positions doing better. Precious metals and AAPL crop first to mind, but there are many others. And some of the hated positions, e.g. RIMM, NOK, X, have been perking up. I don’t know how long this lasts, but it is the theme for now and it makes no sense to fight it.
Big picture, this is consistent with two big economic themes. One is that central banks have done a good job quelling crises, and few appear to be imminent. Of course we could always get hit out of left field by something nobody is expecting, but for the first time in years, there’s very little talk about bank or nation failure in the US or Europe. This is a major change.
That lead to the major “bear market” in volatility that people are talking about, as evidenced by the fact that the VIX has been quiet all year, at least as compared to the last several.
In addition to the diminishment of tail risk (and again, the Fiscal Cliff or something else, could ruin all of that if it goes badly), there are signs of a return to above-trend growth, of the private sector really kicking into gear. That’s Goldman’s big call for 2013 anyway.
There’s a good possibility that 2012 will be a bookend on the age of crisis (2007-2012 will perhaps be an important period in economic history) and if that’s the case, than the purely macro-driven markets may finally start to give way.
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