An article in the WSJ paper was talking about how a certain stock correlation index shows that stock activity is more correlated (81%) now than ever since the 1987 crash (83%). Basically, groups of stocks over entire markets are now frequently rising and falling together, whereas before, individual stocks were more likely to be moving in different directions. Here’s the online article http://online.wsj.com/article/SB10001424052748704258604575361022564322124.html
My guess is that the cause is that investors are spooked and are buying in groups to spread out their risk.
And the effect will be harmful because capital isn’t being directed to where it best serves the consumer. High-performing companies, not being awarded commensurate capital, will start to become more conservative / lazier. Low-performing companies will be emboldened to continue their bad decisions. Here’s an analogy. Imagine if you are the head of a company and you give out the same raise to every employee, based on overall performance. The high performers will be more motivated to leave or slack off, because they won’t receive direct rewards for doing well. Meanwhile, low performers will be attracted to your company.
Do you agree with my assessment of the cause and effect? How important is this index as a way of predicting crashes?
I’ve seen this kind of pattern in the market lately and it also has me concerned. The only hunch I can gather from this is that people are more worried about the general economy than they are the actual companies and markets within it. I think it has to do with a lack of confidence in recovery and regime uncertainty.
More regulations, more riging of the stock market, and distorting the free market has been causing mal-investment in the markets for a long time now. Of course, now it’s worse than what it has been in a long time. We’re not going to see “very efficient” capital markets for a while if I had to take a guess. The new financial bill that’s getting support won’t make this any better, either.
I think it has to do with a lack of confidence in recovery and regime uncertainty.
A minor point: it doesn’t help with exchanges allowing front-running, and also exchanges intervening arbitrarily and rolling back spurious HFT (high frequency trading) algorithm-generated trades. A lot of investors are irked by HFT’s in general, but I think the real problem is the arbitrary rollbacks: if the HFT outsmarts you, you lose; if you outsmart the HFT, then you still lose.