Where Has All The Correlation Gone?

Remember last summer and fall when the market action dictated which direction most stocks would go? Those days where breadth was miserable one day but shining the next. Correlation was high, nearly reaching 90%. Confusion was at its peak as the markets were jolted daily by news, innuendo, rumors and conflicting viewpoints. It seemed like a roller coaster ride that would never end – and I was one of the participants feeling squeamish from the ride. In January of this year the great correlation bubble burst and stocks finally moved without external influence.

The market correlation with stocks has been heading lower all year long, and now hovers in the 50% area (see chart). What does this mean? Simply put stocks can move on their own without the push of markets such as the ES (spx futures contract), Russell 2K (futures) or other big index. The cap weighted indices influence all stocks to move in the same direction when correlation is high. Stocks become disconnected from the market movement as we see more funds picking stocks rather than futures (but using the futures to hedge positions). We saw this in fall of 2011 into the end of the year, I wrote a piece on this earlier on this very phenomenon. Futures traders are now frustrated with the lack of volume AND the weak price movement.

Futures traders have been literally put to sleep by the lack of action. This most recent expiration week saw a range during real time hours of 16 handles top to bottom in the S&P 500 – the entire week! Remember the days when we would see 16 handles a few times during the day, or even drop 16-20 handles to start the day and move lower and then come back up? Without much range or movement futures traders are left to pick up the crumbs or coins left on the floor – and then quickly get out of the way of the steamroller. Thursday was a great example. The market opened lower and continued to descend and make a bottom about 9 handles below the prior day’s close, yet it snapped back forcefully and 90 minutes into the session the markets only had a negligible loss. If you didn’t move out of an early short position quickly or stopped out then you were smashed.

Lack of market correlation is a stock picker’s paradise.  Stocks performing based on the technicals or fundamentals is a great advantage.  We have some names today that are at/near all time highs such as Apple, Google, Amazon.com and a slew of names near lows, like Coach, Intel and Checkpoint Software.  Separating the wheat from the chaff, stocks not getting punished just because the entire market is getting blasted.


Bob Lang is the Senior Market Strategist and trades various option strategies for option trading newsletter Explosive Options