A Reflection in the 11th Hour

Focus: MARKETS

John Stephenson Image John Stephenson President and CEO, Stephenson & Company

If how we end the year is any indication of how the next one will begin, we're looking at more political grudge matches that work less for the economy and more for the politicians, with the economy—and citizens—paying the biggest price for the spectacle, notes John Stephenson of Strategic Investor.

The damage to the cult of equities from the force-fed housing booms on both sides of the Atlantic, the dot.com crash, the bailouts of Wall Street, and the ongoing political gridlock in Washington and Brussels has been immense.

Despite solid gains this year for the S&P 500 and for the Nikkei—which boasted a 23% return for the year, its best return since 2005—investors are running scared. Investors have flocked to the relative safety of bonds, which on a cumulative basis have outperformed US stocks for over 31 years. Even shell-shocked pension funds are fleeing to bonds on central bank promises of sustained short-term rates of zero.

Not only are investors shunning stocks, but correlations between stocks are high, suggesting that the return for stock picking is minimal. The KCJ Index, which measures the expected average correlation of price returns between S&P 500 components, confirms that correlations are way above normal.

Because of the tighter than normal correlations not only between individual stocks but between markets, investors have adopted a broad-based approach toward securities, selling or buying index futures and ETFs rather than trying to cherry pick the individual market constituents with the best fundamentals. Increasingly this macro madness has had commodities, bonds, and stocks acting as a single trade—risk on, or risk off—buy commodities, stocks, and bonds or sell them all.

But that isn’t how markets are supposed to work.