Thoughts from Our Domestic Equity Team
Equity correlations are falling considerably as investors shift their attention from broad macro events to company-specific fundamentals. We find this to be encouraging for a couple of reasons. First, low correlations make for better diversified portfolios. The more that stocks move independent of one another, the more likely it is that their fluctuations will cancel each other out and result in a lower volatility portfolio. We have in fact seen that play out in the market as the daily move in the S&P 500 this year has averaged just 0.42%, the lowest level in 20 years.
Second, we believe that reduced correlations create a more benign environment for active managers like ourselves. When stocks are mostly moving in lockstep based on high level macro events (e.g. the financial crisis, fiscal cliff, etc.), the implication is that company-specific fundamental drivers are having little impact on market prices. This can create a situation in which one may correctly analyze a company, but not be rewarded for it in terms of stock price appreciation. With this in mind, it is not all that surprising that only one in three active managers surpassed their benchmark last year, and only one in five managed to do so in 2011 (as reported by Bloomberg on Jan 28th 2013, citing data from Bank of America). Recent market action suggests that equities could be transitioning into what we would consider to be a more normalized environment in which company-specific fundamentals are again key drivers of stock price. Not only would this enhance the potential for good ideas to generate outsized returns, it would also result in better diversified, lower risk portfolios.
Submitted by: Jason Sheer, CFA – Portfolio Manager
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