This post-election market shift could be a game changer for investors
Edward J. Perkin, Chief Equity Investment Officer
Boston - One of the most stubborn stock-market trends in place since the financial crisis has broken down in recent weeks, but it should be viewed by investors as a healthy development.
Specifically, the correlation between sectors has fallen dramatically since the U.S. presidential election as investors try to determine the potential winners and losers under a Trump administration. Average sector correlations have fallen to the lowest level since 2009, according to ConvergEx Group. Correlations measure the historical tendency of securities or sectors to move in lockstep.
Meanwhile, the amount of individual stocks moving together -- as measured by the CBOE S&P; 500 Implied Correlation Index (JCJ) -- has declined to near historical lows, according to Bloomberg. The chart below shows how the CBOE S&P; 500 Implied Correlation Index has declined sharply after the election.
Blog Image Perkin 12/20
Much of this change appears to be driven by the significant sector rotation after the election. For example, financial and energy stocks have been bid higher by investors, while healthcare and technology are among the biggest recent losers.
This shift in tone is a potentially huge change for investors who have gotten used to a market largely driven by central bank stimulus and broad macro currents. When correlations are high and the market is moving in a herd-like fashion, fundamental research and choosing the right sectors and stocks aren't rewarded as much. Rather, the main question is simply whether to be in or out of stocks. That may be changing.
Also, the recent outsized sector moves in both directions could create opportunities. For example, investors may have gotten too enthusiastic on some industries under a Trump administration, while sell-offs in other parts of the market could be overdone. That creates the opportunity to fade the rallies in some sectors, and buy the dips in others.
It's healthy to see some sectors rise and others fall, rather than move together as a pack. Of course, a sudden macro event such as another debt flare-up in Europe or China could cause correlations to spike again. Hopefully, we're moving into the next phase of the cycle that isn't simply a tide that lifts (or sinks) all boats.
Bottom line: Since Election Day, investors have been singularly focused on the impact that new policies out of Washington may have on the economy and markets. Potential winners and losers are emerging and the market is moving less like a herd, which could reward fundamental analysis and active management.
Equity securities are sensitive to market volatility.
