ConvergEx: ETFs Show Correlations Falling

February 02, 2011

A look at ETF trading patterns show correlations fell sharply in January, ConvergEx’s Colas says.

Correlations between various asset classes in financial markets, as measured by a number of exchange-traded funds, have collapsed in the past month—a positive, if less-than-conclusive, sign financial markets may be on the mend, ConvergEx Group’s Chief Market Strategist Nicholas Colas says.

Colas said ConvergEx’s sampling of 19 market-, sector- and asset-type ETFs shows that the correlations of returns for everything from industry sectors to precious metals to fixed income to currencies are reaching their lowest levels in more than 12 months.

Since the market crash of 2008-2009, various parts of the financial markets have moved almost in lock step in what many have characterized as a “risk on/risk off” trading pattern. Colas said his findings bode well for a return to healthier markets, where diversification provides incremental risk controls that weren’t terribly available in 2010.

“One month does not a trend make, but in addition to starting off the year with a ‘bang,’ this move lower for correlations is a long-awaited piece of good news for fundamentally-oriented, bottom-up money managers,” Colas wrote in his report, noting that he was surprised by the findings.

Among the findings of ConvergEx’s research are:

  • Industry sector correlations to the S&P 500 averaged 72.4 percent for January, the lowest number in 16 months. April 2010 was the next lowest, at 77.9 percent, but there hasn’t been a month below 80 percent otherwise, he said. Consumer staples stocks, which are down 0.75 percent year-to-date in an up market, saw their correlation to the S&P 500 drop to 41 percent from 80 percent in December.
  • Gold and silver, which should have no common price movement to financial assets, traded that way in January, with modestly negative correlations. These were as high as 50 percent in November 2010, Colas said.
  • Australian dollar and euro correlations plummeted to 0-20 percent from +60 percent in the 2010 fourth quarter.
  • Corporate bond prices, which were generally less of a problem in the past year in terms of sensible correlation levels, also showed similar movement. High-yield bonds, which are essentially the fixed-income world’s version of equities, showed 62 percent correlation, while high-grade corporates were at 15 percent, Colas said.


“The correlation data from January was, in all candor, plainly surprising to me,” Colas wrote. “We’ve lived in a world of ‘Risk on, risk off’ for so long that I genuinely thought that markets were broken, or at least fundamentally harmed. Still, I am not prepared to ring the ‘all clear’ sign just yet.”

Colas said the current economic recovery is very different from many in the past, most notably in terms of the cost of money. He noted that it wouldn’t surprise him if high correlations were some kind of “twisted – and unhealthy – new normal.”

‘Olive Branch’ For Options Traders

Colas also wrote that the recent drop in correlation among the industrial sectors of the major indexes hasn’t resulted in a break to new lows for the CBOE Volatility Index, the market’s leading measure of volatility.

The VIX, or “fear gauge,” as it’s sometimes called, now hovers around 17, well above its one-year low of 15, he said.

“Options traders have worried aloud that the VIX might have been setting up for a move to retest its all-time lows of 10. That now seems much less likely,” Colas said, calling that reprieve “an olive branch to options traders.”

Historical 30-Days Correlation Against S&P 500


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