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On Volatility, Correlation, And Sentiment Shifts

Tyler Durden's picture




 

Since the peak in the S&P 500 around two weeks ago, equities and their sectors have traded in a considerably more disperse manner than one would expect given all the talk of central-bank intervention, liquidity-gasms, and monetization. This is borne out empirically as the average pairwise realized correlation within the 100 stocks of the S&P 100 and the 125 credits of the CDX investment grade credit index has dropped dramatically. Extreme peaks or troughs in realized correlation have tended to coincide with notable (and tradable) trend changes in the market - though we note, as shown below, that the moves are not always so clearly bullish or bearish. Critically, the outperformance of Healthcare and underperformance of Industrials and Materials in the last two weeks suggests more than a little apprehension at the Central Banks being able to 'bridge' yet another global slow-down with money-printing.

This chart shows the average pairwise correlation between all 100 stocks within the S&P 100 (so it is the average of 100x99/2 correlations for each day). The last few weeks have seen the correlation between these 100 stocks plunge to an extreme...

 

the same is very evident in investment grade credit...

 

In the past few years - the extremes in equity realized correlation have produced the following results:

Troughs in correlation (<0.15)

  • 4/26/10... SPX fell 12.6% in 8 days - marked top of that cycle
  • 11/3/10... SPX rallied 2.5% in a day then fell 4.5% in next 7
  • 1/21/11... SPX rallied 1.4% in 5 days then fell 2% in a day
  • 4/20/11... SPX rallied 3% in 6 days and fell 8% in next 32 days
  • 5/19/11... SPX fell 2.5% in 2 days
  • 3/2/12... SPX fell 2.5% in 3 days

Peaks in correlation (>0.75)

  • 5/25/10... SPX rallied 8.7% in next 18 days (interim trough)
  • 8/11/11... SPX rallied 11.7% in next 16 days (was interim trough)
  • 10/27/11... SPX fell 10.4% in next 20 days (interim peak)
  • 12/8/11... SPX fell 5.1% in next 8 days

but Volatility seems clearer directionally:

Troughs in correlation (<0.15)

  • 4/26/10... VIX jumped 23 vols in 9 days
  • 11/3/10... VIX rose 3 vols in 9 days
  • 1/21/11... VIX fell 2.3 vols in 4 days then rose 4 vols in a day
  • 4/20/11... VIX rose 3.5 vols in 11 days
  • 5/19/11... VIX rose 7.2 vols in 19 days
  • 3/2/12... VIX rose 3.6 vols in 2 days

Peaks in correlation (>0.75)

  • 5/25/10... VIX fell 10.7 vols in 17 days
  • 8/11/11... VIX fell 7.4 vols in 4 days
  • 10/27/11... VIX jumped 9.3 vols in 3 days
  • 12/8/11... VIX fell 9.9 vols in 11 days

So empirically there appears to be some regime shift when correlations become extremely positive or neutral.

From the lows in early June, sectors broadly speaking rallied together. Since H2 2012 began - post EU Summit and 'aided' by the Draghi 'believe me' speech - sectors have been notably more disperse, with Energy, tech, and financials leading and Utilities lagging notably, but...

 

Since the S&P 500 double-topped a couple of weeks ago, it appears the sectors one would expect to be #winning have not been - as Healthcare outperforms and Industrials and Materials underperform...

 

The relative stability and tiny ranges in the last few weeks may have some to do with the drop in correlation but it does seem that while most 'expect' some liquidity-fueled rally to the moon, those expectations were already priced in and now we are seeing selective exuberance unwound into this strength.

 

One thing seems sure, the plunge in correlation will bring some regime shift - probably rapidly - and we would expect volatility to follow (realized and implied).

 

Charts: Bloomberg and Capital Context

 

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Mon, 09/03/2012 - 19:58 | 2758987 Colombian Gringo
Colombian Gringo's picture

Hang all Banksters, Now!

Mon, 09/03/2012 - 20:16 | 2759022 vast-dom
vast-dom's picture

again all these charts are nice n purdy n shit, but when you have Bernank Ponzi toolbox of hopium it's all just that: nice n purdy n shit but signifying nothing.

Mon, 09/03/2012 - 20:25 | 2759044 AlphaDawg
AlphaDawg's picture

dude, its a bullshit

check out the soverign debt growth rate, that is where the truth lies

Mon, 09/03/2012 - 21:23 | 2759075 vast-dom
vast-dom's picture

there is no truth and reality is whatever you can get away with as clearly demonstrated by the psychotic Bernanke and his sociopathic bankers.

 

ever try and reason with a crazy bpd bitch? it's always your fault! that's how the merry fed ponzinators roll.

Mon, 09/03/2012 - 21:45 | 2759200 sablya
sablya's picture

I agree man, this crap has gotten real old.  The market is nothing more than a slobbering dog waiting for some table scraps from the banker's table.  It used to be possible to understand the markets in terms of fundamentals such as future earnings growth, debt, balance sheets, dividends, along with economic considerations.  Now all of that is irrelevant.  There is only one thing that matters now.  The exceptional has become the norm and the norm has become irrelevant.  

A few years ago, if someone would have said that China's PMI had entered a contraction, the market would have sold off hard.  Now it either ignores that reality or it rallies.  It's all complete bull$Hit and I don't think it is worth being in the markets any more.  I can't with good conscience go long in this crappy market but I can't go short either.  So, there is nothing to do but sit in cash and watch the fools run the ship aground while drinking choice champagne from their $2500 shoes.

Mon, 09/03/2012 - 22:09 | 2759234 gjp
gjp's picture

Well said, sablya and vastdom. A disgusting state of affairs.

Tue, 09/04/2012 - 03:49 | 2759514 Colonel Klink
Colonel Klink's picture

Uhhhhhh, we're already about 4 years late.

Mon, 09/03/2012 - 19:59 | 2758988 MachuPicchu
MachuPicchu's picture

By the way, have you seen The Economist world debt comparison? http://www.economist.com/content/global_debt_clock

 

Mon, 09/03/2012 - 19:59 | 2758989 fonzannoon
fonzannoon's picture

Fine I will take the bait here. I think the vxx looks dirt cheap. Friday I almost grabbed it at 11.50. I bought a ball shocker instead. So now whenever I am about to buy it I just shock my balls instead.

Mon, 09/03/2012 - 20:28 | 2759058 Cheshire
Cheshire's picture

I bet you could market the vxx ball shocker with some great success. I was expecting a reverse split.

Mon, 09/03/2012 - 20:28 | 2759060 Dr. Engali
Dr. Engali's picture

I typically buy volatility when the vix is closer to ten. My gut tells me to buy volatility at 15,but it's hard to tell in this market with all the financial suppression.

Mon, 09/03/2012 - 20:45 | 2759088 chump666
chump666's picture

Wall Street is about to profit take hard.  The markets are already juiced, there is a huge divergence in the rolling correlation with commodities and equities.  Stocks will re-price lower, how low? Hard to say, but the market trades off news (bs or otherwise).  IMO the market has mis-priced QE and China stimulus.

Set to disappoint.  Could sell hard prior to 12 Sept (German crt thing), rally on QE lite (or sell)

Mon, 09/03/2012 - 20:52 | 2759102 fonzannoon
fonzannoon's picture

I have 145k on the headline NFP Friday. I say that puts Ben on the sidelines in Sept. The markets finally realize they may be adrift on their own for a while and start to drop. They approve the ESM on the 14th and that keeps things stabilized. I just think the markets will walk a tightrope between Europe and the US until one of them actually falls off and takes the other one with them. Germany can not carry the EU and the US may have a few years more at best before reality hits like a ton of bricks. Until then it's just headline to headline.

Tue, 09/04/2012 - 00:23 | 2759398 chump666
chump666's picture

Pretty much.

Mon, 09/03/2012 - 20:00 | 2758990 vinayjha
vinayjha's picture

Dow is up 560 point since Draghi gave speech he will do everything to save his job and VIX is up 6%

http://www.freefdawatchlist.com/2012/09/earning-watch-for-sept-4th-7th-bth-sfd.html

Mon, 09/03/2012 - 20:03 | 2758996 The Shootist
The Shootist's picture

No, "On Heroes and Hero Warship," is where it's at.

Mon, 09/03/2012 - 20:04 | 2758999 The Shootist
The Shootist's picture

And Spidey towels.

Mon, 09/03/2012 - 20:07 | 2759001 chump666
chump666's picture

Excellent summary ZH

The market is staggering...and when it staggers:

http://youtu.be/3SPjy5RlqFE

Mon, 09/03/2012 - 20:22 | 2759039 fonzannoon
fonzannoon's picture

Chump as long as we are sharing I think crude continues to be the....http://www.youtube.com/watch?v=MYtjpIwamos

Mon, 09/03/2012 - 20:27 | 2759054 chump666
chump666's picture

hahahahahaha yes! 

 

Tue, 09/04/2012 - 02:21 | 2759464 chump666
chump666's picture

One of the BRICS is about to blow - India, China won't be far off. 

*Concerns over India’s growth, high inflation,  ratings warning by S&P underpin

Tue, 09/04/2012 - 06:20 | 2759575 asteroids
asteroids's picture

The Penguines "know" that there is something evil in the water that wants to eat them, so they stay out and gently push their brothers to their death hoping a sacrifice will give them a chance to eat.

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