Talk About Group Think…

09/16/2011 8:30 am EST

Focus: MARKETS

You know things are out of whack when major market correlations have reached the point where there’s virtually no difference between their respective performances, writes Todd Shriber of the ETF Profit Report.

One of my favorite themes is back in the headlines. That being correlation of various sectors and asset classes to the S&P 500.

Previously, I’ve been strident in my opposition to blaming ETFs for this scenario, and I see little in the way of compelling evidence to make me change my mind. Still, investors are facing quite the correlation conundrum these days, and what that means is the number of so-called "safe haven" choices for investors are dwindling.

In a note published on Tuesday, Nicholas Colas, chief market strategist at ConvergEx Group, said the following: "Average correlations between the ten major sectors of the S&P 500 have reached 97.2%, from 82.1% just three months ago. That’s the highest level of such common price action since the financial crisis."

The old saying "A picture is worth a thousand words" is applicable here.

http://www.globalprofitsalert.com/wp-content/uploads/2011/09/spy-xle-xlf-xlk-xlp-xlv-perf-chart.gif

That’s a chart of the SPDR S&P 500 (SPY) and the SPDR funds representing energy, financials, technology, consumer staples, and healthcare. Obviously, those are some pretty intense correlations, with the only legitimate divergence coming from financials simply because they’ve been stinking up the joint.

Problem is—and this was noted in various forms across multiple outlets on Tuesday—it really doesn’t matter what you own these days, because fearful markets lead to elevated correlations. Put another way, Investor A owns corporate bonds, Investor B owns SPY and Investor C owns the iShares MSCI Emerging Markets Index Fund (EEM) and chances are their returns are going to be comparable in this environment.

Not to be trite, but I’m not getting too worked up about this situation. Nor should you. There’s been a lot of noise lately about ETFs and correlations.

My argument is this is the ideal time to be involved with select ETFs. Correlations were high in 2008 because of the collapse of Lehman Brothers, and they’re high today because Europe is simply a mess.

Blaming ETFs for these situations is an appalling inaccuracy. Did ETFs bankrupt Lehman and Greece? No, they didn’t.

On Monday night, the hopefully future Mrs. Shriber asked me to explain correlation to her. After gathering myself from the pleasant shock of her being interested in ETFs, I explained it to her.

Let me preface the following by saying she doesn’t work in finance, and she’s about as interested in the stock market as you and I are in watching grass grow. She says to me: "Well, shouldn’t people just own hard assets?"

Ah, smart and beautiful. I’m talking about the chart and the girl. In other words, busting correlation doesn’t require an MBA from Harvard. In fact, correlation has presented savvy investors with an opportunity to beat the anemic returns plenty of Harvard MBAs are going to have explain at the end of this year.

Correlation? Fear not, because the profitable trades are still out there.

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