One of the big issues with investing in 2011 was elevated correlations across risky financial assets. In other words, asset classes like stocks, corporate bonds, and commodities were moving up and down, hand-in-hand.
Correlations were particularly high within the stock markets.
High correlations make it incredibly difficult for investors and portfolio managers to diversify away risks.
However, after hitting historic highs in 2011, correlations within the stock market have plummeted to historic lows. This is according to new research published by Oppenheimer’s Chief Investment Strategist Brian Belski. From a note to clients this mornng:
From our perspective, portfolio tracking error for most money managers has been relatively low over the past several years and understandably so since high stock correlations (Chart 1) virtually eliminated the reward for having more aggressive portfolio positions. However, 2012 has been an entirely different story as correlations have fallen dramatically with current levels near their lowest levels in over the past 25 years. This is particularly interesting considering January’s strong market performance, which implies that while some stocks had very strong gains, others had very weak gains—a sharp divergence from performance patterns exhibited toward the end of 2011.
So, what does this mean?
Belski notes that stock picking has become important again. In other words, active management strategies –as opposed to passive strategies (ie indexing)–will offer additional value. From Belski’s note:
Since we believe that current stock correlation trends are likely to persist throughout the year, it is important for investors to place additional emphasis on active investment strategies, in our view. In fact, we continue to believe that those investors that focus on proper stock selection will be the ones to ultimately be rewarded.
Belski reviewed the performance of various active management benchmarks since 1990 and noted that most strategies outperform passive strategies during periods of low correlation.
Photo: Oppenheimer & Co.