Are you interested in getting involved in active trading but concerned that you will have a hard time beating the broader markets?
Any efforts to do so just got easier, as correlations have been decreasing recently, at least according to research conducted by ConvergEx chief market strategist Nick Colas, CNBC reported.
The market has had a tendency over the last several years for different asset classes - including all stocks - to follow each other in their price movements, according to the news source. However, these correlations have recently fallen to their lowest level in several years.
Easier active trading
If the various assets that constitute the global markets do not have high correlations, it will make it easier for you to succeed in active trading easier. In the event that the prices of different securities are all moving in the same direction at the same time, it will be more challenging for you to pick the ones that outperform the broader markets.
In addition, any efforts you make to diversify will likely be more successful. The idea behind diversification is combining different assets that do not follow each other in terms of their price movements. Ideally, if one component falls in value, the remaining parts should experience a corresponding gain so that the entire portfolio does not change in value.
Challenges in bear markets
However, this situation can be difficult to achieve. In addition, obtaining such a scenario can become particularly difficult in bear markets. This frequently happens since in these downward trending markets, panic selling can cause global investors to push all assets down in value at the same time. Since these securities are all depreciating simultaneously, their correlations become higher.
Under such circumstances, it can be more difficult for investors to pick out assets that outperform the broader markets. A perfect example of such an occasion is the financial crisis. During this time, many different assets plunged in value, and correlations rose.
Since the economic downturn, we have coped with situations where assets follow each other significantly and the broader markets engage in a combination of "risk-on" trading, where securities considered to be risky rise in value, and "risk-off" trading, where investors flee these riskier assets for ones that are safer, according to CNBC.
"This is not the way global stock and bond markets are supposed to work," Colas stated in reference to high correlations, the media outlet reported. "The bedrock of all academic research into the behavior of capital markets rests on the value and power of diversification. If all (asset classes) move similarly, as they have for over half a decade, then there is simply less reason to put money to work."
Colas noted this situation, stating that it essentially thwarts the efforts of global market participants to diversify, Forbes reported. He noted that in July, the correlation between the 10 components of the S&P 500 Index and the overall stock market was 70 percent. This figure was sharply lower than the 89 percent relationship that existed in June.
He specifically noted that the utilities component had a 47 percent correlation to the broader stock market in July, while tech had one of 58 percent, according to CNBC. He noted that not only did the correlations that these domestic equities have to the broader markets fall, but that such a decline was also experienced in stocks representing companies in other nations.
Colas stated that during the month, equities in developed international markets had a 76 percent correlation to the broader stock market, while emerging stocks were at 58 percent, the media outlet reported.
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