•Cash Best as Record Correlation Coefficient Hints Herd Investing Collapse

Discussion in 'Wall St. News' started by ByLoSellHi, Jun 29, 2009.

  1. http://www.bloomberg.com/apps/news?pid=20601087&sid=aaeSiksLwotY

    Cash Best as Record Correlation Coefficient Hints Herd Collapse
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    By Eric Martin and Michael Tsang

    June 29 (Bloomberg) -- Investors are moving in lockstep like never before, driving up stocks, commodities and emerging markets and risking a replay of last year, when they all plunged the most since World War II.

    The Standard & Poor’s 500 Index, whose increase in the past three months was the steepest in seven decades, is rallying in tandem with benchmark measures for raw materials, developing- country equities and hedge funds. The so-called correlation coefficient that measures how closely markets rise and fall together has reached the highest levels ever, according to data compiled by Bloomberg.

    The herd mentality threatens to leave investors with no refuge amid signs that the worst U.S. recession since 1958 isn’t abating. While bulls say it makes sense that markets climb together after the S&P 500, copper and oil lost more than 38 percent in 2008, RiverSource Investments LLC and Harris Private Bank are telling clients that diversification strategies to smooth out returns won’t work. They suggest shifting money to cash and bonds on concern gains will evaporate.

    “If everything’s moving in the same direction, you can’t build a portfolio that has varying degrees of risk,” said David Joy, chief market strategist at RiverSource, which manages $125 billion in Minneapolis. “If we don’t start to see tangible evidence of economic improvement, there’s enough tentativeness among investors that they may be quick to retreat.”

    Lowering Risk

    RiverSource is using corporate bonds rated A, BBB and BB by S&P to protect against losses in other markets, Joy said. Jack Ablin, who oversees $60 billion as chief investment officer at Harris Private Bank in Chicago, raised cash to lower risk and is shunning traditional diversification strategies such as buying Treasury bonds on concern that increased government borrowing will erode returns.

    Stocks and commodities that benefit most from economic growth have climbed in concert over the past three months on speculation that the first global contraction since World War II is easing.

    In the U.S., the Conference Board’s measure of leading economic indicators increased in April for the first time since June 2008 and rose again last month. Analysts covering S&P 500 companies boosted 2009 profit estimates for the first time this year in May as economists predicted the U.S. economy will start to expand next quarter, weekly data compiled by Bloomberg show.

    The S&P 500 has added 36 percent from a 12-year low in March, increasing on 56 percent of the days during that span. The Reuters/Jefferies CRB Index of commodities has advanced 25 percent from its trough, rising 57 percent of the time.

    Twin Killing

    The gains pushed correlations between the indexes to 0.74 this month, based on percentage changes over the past 60 days. That’s the highest in at least five decades, data compiled by Bloomberg show. A reading of 1 means two assets move in tandem, while zero means they are independent.

    The correlation never rose above 0.66 before this month.

    Gains in U.S. stocks have mirrored those in crude oil as never before, with correlations above 0.7 this month, according to data compiled by Bloomberg. For the MSCI Emerging Markets Index, the relationship is the tightest since Russia defaulted on its debt in 1998. The correlation between the S&P 500 and an HFRI index of fund of hedge funds, based on percentage changes in the past 12 months, reached 0.5 in April for the first time in almost five years, monthly data compiled by Bloomberg show.

    ‘The Same Trades’

    “I have a lot of friends in the hedge-fund world; they talk to each other and have many of the same trades,” said Nick Sargen, chief investment officer at Fort Washington Investment Advisors in Cincinnati, which oversees $27 billion. “These are people who say, ‘I see a pattern, and I’ve got to jump on.’”

    The S&P 500 plunged 57 percent from a record 1,565.15 in October 2007, while developing-nations stocks lost two-thirds of their value as the world’s largest financial companies racked up almost $1.5 trillion in losses from the collapse of the subprime mortgage market and investors sold everything but the safest assets. Oil tumbled 78 percent from a record $147.27 a barrel in July, while the CRB retreated 58 percent.

    Harry Markowitz, 81, who won the Nobel Prize for economics in 1990 for his work on portfolio theory, says that last year’s collapse reinforces his view that even the most unlikely outcomes are possible in any year.

    ‘Thundering Herd’

    “The thundering herd is still with us,” said Markowitz, a professor of finance at the Rady School of Management at the University of California, San Diego. “Nature draws into a bushel basket full of returns and finds a next return every year, and I believe there’s another 1929 somewhere in that bushel basket. 2008 was not a refutation, it was a confirmation.”

    For James Swanson at MFS Investment Management, the simultaneous rallies in stocks, commodities and emerging markets are a precursor to a rebound in the economy.

    “These whiffs of optimism we’re getting are well founded,” said Swanson, the Boston-based chief investment strategist at MFS, which oversees $134 billion. “We’ve priced in the normal exit of a bad recession. In the U.S., there could be a new dawn of profitability.”

    Some investors remain skeptical the recession is about to end. The economic recovery hasn’t begun and will be a “slow process,” billionaire investor Warren Buffett said in a June 24 interview with Bloomberg Television.

    The unemployment rate, which jumped to an almost 26-year high of 9.4 percent in May, will probably exceed 10 percent, said Buffett, the chairman and chief executive officer of Omaha, Nebraska-based Berkshire Hathaway Inc. Earnings for companies in the S&P 500 have declined a record seven consecutive quarters and are estimated to slide for two more, according to analysts’ estimates compiled by Bloomberg.

    Cutting Profit Estimates

    Analysts have trimmed their projections for a fourth- quarter profit increase to 62 percent from a prediction of 95 percent growth when stocks began rallying in March.

    Now, options traders are paying more to protect against a drop in the S&P 500 versus the cost to wager on gains than at any time since September, when the collapse of New York-based Lehman Brothers Holdings Inc. froze financial markets.

    So-called implied volatility, which measures the expected price swings of an underlying asset and is a barometer of options prices, for contracts that lock in gains should the S&P 500 fall at least 10 percent in three months rose to 30.5 percent on June 12, data compiled by Bloomberg show.

    That’s 42 percent higher than call options that enable traders to profit if the index rises at least 10 percent in the same period, the steepest so-called implied volatility skew since Sept. 19, four days after Lehman’s failure.

    “There’s nowhere to hide,” said Joseph Mezrich, the head of quantitative research at the U.S. brokerage unit of Nomura Holdings Inc. in New York. “The problem of correlations is growing, and I don’t think it goes away.”

    To contact the reporters on this story: Eric Martin in New York at emartin21@bloomberg.net; Michael Tsang in New York at mtsang1@bloomberg.net.
    Last Updated: June 28, 2009 19:01 EDT
  2. ba1


    Green shoots theory. Oh, missed the "i" next to the "o", twice.
  3. Cutten


    I hate the way bloomberg articles are written as though unqualified financial journalists with no track record of trading or investment profits are able to predict the markets. They should shut the fuck up and stick to reporting facts.
  4. The article is pretty much based on economists' views such as Markowitz:

    "Harry Markowitz, 81, who won the Nobel Prize for economics in 1990 for his work on portfolio theory..."