Embracing Distinction in S&P 500 as Correlations Unwind: Options
By Joseph Ciolli
(Bloomberg) — Damped concerns over a global economic
slowdown and diminished volatility have equity investors acting
more independently than at any point in the past two years.
The Chicago Board Options Exchange?s S&P 500 Implied
Correlation Index, which uses options to measure expectations
about whether Standard & Poor?s 500 Index stocks will move in
unison, has plunged 17 percent this year to the lowest level
since 2012. This helps explain better performance in large-cap
mutual funds this year, where 46 percent are beating benchmarks.
The S&P 500 has rallied to record levels as oil prices
stabilized and Greece reached a bailout deal, while
accommodative central bank policies from Europe to Japan and the
U.S. eased concern about the global economy. With uncertainty
over such macro issues fading, investors are left to focus on
the individual characteristics of companies rather than follow
trends in market momentum, according to Kevin Divney at
Beaconcrest Capital Management LLC.
?The market has been pricing more on company fundamentals,
earnings prospects and the fact that the U.S. looks relatively
appealing versus other equity markets,? Divney, chief
investment officer at Beaconcrest, said in a phone interview.
?If you look at what?s been driving returns recently, it hasn?t
been momentum, it?s been valuation and quality.?
Market Breadth
The S&P 500 has added as much as 1.7 percent since a Dec.
23 high, reaching another record of 2,117.39 on March 2.
Meanwhile, the number of stocks in the index making 52-week
highs has slipped more than 20 percent over the same period. The
benchmark gauge increased 0.1 percent to 2,101.04 Thursday.
When companies fail to match the moves in the broader
equity benchmark, individual stock selection becomes more
important, Divney said.
The CBOE implied correlation gauge decreased 1.2 percent to
51.87 yesterday, the lowest level since November 2012, according
to Bloomberg data.
The CBOE Volatility Index, which has dropped 27 percent
this year, slipped 1.3 percent Thursday as European Central Bank
President Mario Draghi primed investors for the first asset
purchases in a quantitative easing program that will amount to
60 billion euros ($66 billion) a month.
Central Banks
The European stimulus plan, along with easing measures from
the Bank of Japan designed to stem deflation, has lifted
sentiment and emboldened investors to be more autonomous,
according to Jim Paulsen of Wells Capital Management. In the
U.S., Fed Chair Janet Yellen said last week inflation and wage
growth remain too low for the central bank to raise rates at its
next meeting.
?There?s not a ?sell all? or ?buy all? mentality anymore,
and that?s happened as investor confidence has improved,?
Paulsen, the Minneapolis-based chief investment strategist at
Wells Capital Management, which oversees $338 billion, said in a
March 3 phone interview. ?People aren?t looking at stocks as a
single asset class for risk-on or risk-off.?
According to data compiled by Goldman Sachs Group Inc., 46
percent of large-cap core mutual funds are outperforming the S&P
500 year-to-date and the typical hedge fund has returned 1.5
percent after trailing the benchmark index by 11 percentage
points last year. In 2014, only 25 percent of actively managed
equity mutual funds beat their benchmarks, the lowest rate since
1995, according to data from Morningstar.
With the S&P 500 and Dow Jones Industrial Average hovering
near all-time highs, some market strategists see equity prices
as overextended.
?Stretched? Market
To Peter Cecchini of Cantor Fitzgerald LP, the current low
level of implied correlation does indeed benefit stock-pickers,
but they may not be happy with the direction the market takes in
the longer-term.
?With low correlation like this, volatility coming in,
weak breadth, and earnings being revised lower, this particular
case supports the conclusion that equity markets are pretty darn
stretched,? Cecchini, the New York-based chief strategist and
global head of macro equity derivatives at Cantor Fitzgerald,
said in a March 5 phone interview.
Earnings growth for companies in the S&P 500 will contract
4.9 percent for the first quarter of 2015, according to analyst
estimates compiled by Bloomberg. As recently as Jan. 23, the
forecast for profit growth was positive. Revenue is estimated to
decline 2.9 percent for the period.
Still, strategists remain bullish on equities in 2015. The
benchmark index will increase nearly 7 percent to 2,237 by the
end of the year, according to the average of 21 equity
strategists surveyed by Bloomberg. The Nasdaq Composite Index
closed above 5,000 for the first time in 15 years on Monday and
is within 1.3 percent of a record.
?Someone that specializes in fundamentals is likely to do
better this year if implied correlation continues to stay low,?
Terry Morris, a senior equity manager who helps oversee about
$2.8 billion at Wyomissing, Pennsylvania-based National Penn
Investors Trust Co., said in a March 5 phone interview. ?It?ll
still take work, but there are going to be opportunities in
stock selection.?