As Stock and Sector Correlation Hits Fresh 20 Year Highs, Here is who is Benefiting. Submitted by Tyler Durden
There was a time when being short was a bad idea. Not anymore. As David Kostin’ summarizes in his latest weekly chart packet, the level of 3 month S&P and sector correlation is now at a 20 year high, an environment which never leads to good outcomes for long-only whales, and which has led to sizable outperformance for hedge funds due to their recent loading up on short positions. To wit: “S&P 500 three-month correlation is 0.73, the highest in at least the past 20 years, and up from just 0.44 at the start of August. Sector correlation is similarly high, with all major S&P sectors experiencing realized correlation above their 95th percentile since the late 1980s. While it is difficult to specify a cause for higher correlation, a spike in S&P futures and ETF trading volumes and parallel reduction in open interest held by institutional and levered funds as reported by the Commodities and Futures Trading Corporation (CFTC) indicate significant de-risking in August.” What does that mean for recent performance? Nothing good if one is a mutual fund: “Elevated correlation is generally considered a poor environment for long-only fundamental investors. In highly correlated sell offs the market does not discriminate based on company fundamentals, reducing the value of stock picking. Recent performance trends support that case.” As a result hedge fund LPs are doing ok: “The typical hedge fund has generated a 2011 YTD return of -1% through August 19 compared with a -10% decline for the S&P 500 and an -11% return for the average large-cap core mutual fund.” Alas, if the hedge fund in question is Paulson & Co., this average statistic is very misleading.