Good times end for Europe’s stock pickers – after just three days
The brief respite from painfully high stock correlations that European stock pickers enjoyed after last week’s bailout news ended sharply today, as news of Greece voting on austerity measures sent both correlations and volatility upwards yet again.
It is the latest statistical proof – if any were needed – that markets are returning quickly to a stance of ‘fear first’ these days.
The high intra-market correlations that result from this are poor conditions for stock pickers, because their ability to pick good stocks from bad ones is of limited use if all stocks move uniformly, according to Axoima.
Its analytical software tracks intra-security correlation and volatility, among other variables.
It said correlation between securities fell sharply in response to last Thursday’s European rescue package announcement.
It attributed the retracing of this measure, three trading days later, to the referendum Greek prime minister George Papandreou (pictured) announced yesterday for his citizens.
Eurozone macro concerns are coming again to “the top of people’s minds”, said Olivier d’Assier, Axioma Asia’s managing director.
“By the end of last month, all our risk models were showing that volatility had dropped significantly on the news of the European rescue package for Greece. Additionally, the wide spread between them had declined to just 4% as details of the euro rescue package emerged. This showed a general consensus had emerged in the market about the positive impact of this response.
“The announcement by the Greeks is going to have a big impact on the markets. By the end of this week I expect our risk models to point to increased uncertainty, translating into higher readings for volatility, correlations, and a widening spread among our risk models.”
He said this would mark a return to the “risk environment in September, undoing the good work achieved through the announcement of the rescue package. Markets live week to week as investors lack the confidence needed to make longer-term forecasts.”
He added worse news, and even higher correlations, could come if the Greek public votes against the austerity measures. “We will also see risk spreads across models return to pre-package highs, or higher, if systemic risk from a potential Greek default comes into the picture.”
In coming days Axioma’s analysts will be watching their system for any signs of increased risk from September’s peaks, suggesting “new sources of uncertainty, like a systemic risk on the EU banking sector from a Greek default.
“What investors need to see for volatility and correlation levels to return to the October lows is the same sense of urgency in the implementation of these measures as was shown in their design. Without a credible implementation plan, this is just a plan and it will not convince investors that the worst is behind them.”
D’Assier noted early last month that average asset correlation had jumped from 31.8% over the preceeding five years, to 46% since August. It was at its second highest point since September 2000, lower only than one other peak last year.
He said: “Correlation is a problem for stock pickers because if all the assets are moving together, you cannot pick winners from losers, nor differentiate yourself as a good stock picker from a bad one. There is not a single industry that is not positively correlated to another, whereas 10 years ago a lot were, especially during and after the dot.com bubble.”
Reflecting the flipside of the high inter-correlation statistics, the percentage of FTSE Europe stocks with negative correlations to other benchmark constituents has fallen from an average of 17% from 2000 to 2005, to just 2.2%.