How interesting... All out sector correlation (again)

The S&P 500 sector correlation is at its highest level since '89.

With Global macro-economic factors continuing to drive equity markets, generating alpha (I.e. beating the market) is getting much harder. With the intensification of the Euro debt crisis and the U.S. credit rating downgrade, the correlation amongst S&P 500 sectors has increased rapidly. With sectors (and stocks) moving in lock-step, the average correlation among S&P 500 sectors has exploded, giong from 68% in eraly June to 90% currently, the highest level since at least 1989.

In comparison, the 22-year average sector correlation stands at 57%. The current sector correlation is surpassing the levels hit last summer (87%) and during the 2008/2009 crisis (89%), as illustrated in the chart above.

From a contrarian perspective, however, the last two peaks in sector correlations provided good entry points in the equity market.

Could ETF's be adding to this all out "unification"?

ETFs account for more than 30% of volume in U.S. stock markets, compared with just 2% in 2000. It may be reasonable to expect ETF trading to drive correlation higher because many of the vehicles are tied to stock indexes.

For example, the 10 different industry sectors of the S&P 500 show well over a 95% correlation over the last month, and a low of 72% in February 2011. High yield bond prices are at a 93% correlation to stocks, which is another multiyear record.

This is unusual for U.S. equity markets, which have tended towards lower correlations in rising markets and clustered returns when things get ugly.

It may not mean that we are necessarily in for tougher markets from these points, but it does make the decision about asset allocation more important than sector or stock selection. (At least for the time being)

Best Regards and Safe Investing.

E