Young people can benefit from awareness of current stock correlations

Young people who are looking to invest their money can benefit from knowing about the current trends surrounding the stock market, including the high correlations that are being displayed by many individual equities and the forces helping to drive this behavior.

The correlation, or the extent to which different stocks move in tandem with each other, has been rising in recent months. This aspect of the equity markets has generated discussion surrounding the causes of this behavior.

Equity ETFs

A wide range of market experts have attributed the rising stock correlations to the proliferation of exchange traded funds (ETFs) that investors can use to gain exposure to a wide range of assets with a minimal capital outlay.

The dollar value of all trading involving ETFs tracking the blue-chip S&P 500 Index is on track to be higher than all transactions involving the stocks composing the index for the first time in history, according to Bloomberg.

In July, the total dollar trading volume of the SPDR S&P 500 ETF Trust, the iShares S&P 500 Fund and the Vanguard S&P 500 ETF rose to a 12-month average of $28 billion per day, according to data provided by the news source and Goldman Sachs Group Inc. The figure of $28 billion accounts for 98 percent of the total transactions of shares contained in the blue-chip S&P 500 Index.

Rising correlations and ETFs

Mike Lenhoff, chief strategist at London-based Brewin Dolphin Securities Ltd., told the media outlet in an August 3 phone interview that “ETFs not only have allowed investors to get in on this risk-on, risk-off environment, but they have allowed many an immediate exposure to the market without having to identify the right stocks.”

The news source reports that after both volatility and correlations surged in the aftermath of the 2008 financial crisis, investors flocked to the funds. The increased use of securities such as ETFs and index funds that purchase baskets of stocks has motivated market experts to consider whether the higher correlations have been caused by increased use of the funds, or whether investors have been motivated to use the financial instruments due to higher correlations. 

In addition to high stock correlations, investors face an environment of low bond yields. A recent report released by Moody’s Investors Service predicted that new margin requirements for off-exchange derivatives will boost demand for government securities and reduce bond yields. 

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