After tumbling earlier this month, shares of manufacturers to banks to energy companies are rebounding together, a sign that could lead to more turbulence ahead. The 11 S&P sectors rarely move in tandem but recently, the three month rolling correlation between these sectors rose to 0.73, more than double of 0.37 from last year. (Correlation of 1 signals assets are moving the perfect unison while 0 signals there is no relationship between assets movements with -1 indicating assets are moving in opposite direction).

This is evident from the sell off in Financial stocks upon news of interest rate hike – a key measure of lending profitability.  Usually,  financial stocks rise on higher interest rate news. Instead, financials stocks followed the other sectors dropping 2.5% for the month along with the S&P 500 which is down 3.3% so far.

The one-sided movements of all the sectors in unison suggests that there could be more turbulence ahead until the market stabilizes.

Future Wealth’s View

The high correlation is a problem with no easy solution. Diversification becomes  increasingly difficult and stock picking gets tremendously arduous. But, focus on fundamentals is of paramount importance in these times. Data continues to suggest that global growth is accelerating and US corporate earnings look solid with global economy projected to grow by 3.9% in 2018 and 2019.

The Volatility Index (VIX) has come back down to 19 from 29 last week, suggesting that calm is prevailing in the market. At least, for now. And that explains the ~3% weekly gain in all S&P sectors over the past week.

But just as “One swallow does not a summer make”, reading too much into one good week could be dangerous. Until we see the 11 S&P sectors  decouple themselves, focus on fundamentals returns and defensive sectors can once again begin to withstand market downturns, we could expect investors to continue to behave like fainting goats – if they get startled, their limbs freeze and get stuck on the “Sell” button.

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