By Jason Zweig | Oct. 20, 2011 10:04 am ET
Image credit: Pixabay
The constant chatter lately among professional investors has been that the rising correlation among stocks – their increased tendency to move in lockstep up and down – is making stock picking tougher than ever. After all, if all stocks go down together, then even your top picks are likely to fall whenever the market drops. Conversely, if all stocks tend to rise in unison, then it’s hard to do better than average even with your best ideas.
But, as Stuart Kaye of money manager Matarin Capital points out, this argument rings hollow.
What matters is not whether stocks are all moving in the same direction but, instead, whether they are all moving to the same extent. If all stocks go up at once, but some go up more than others, then stock pickers with the skill (or luck) to hold the biggest movers will rack up the best returns. If all stocks go down at once, but some go down more than others, then managers with the skill (or luck) to avoid the worst losers will have the best records.
What’s more, consider that in 2009, 68% of diversified U.S. mutual funds beat the Standard & Poor’s 500-stock index, according to Morningstar – even though correlations hovered near a 30-year high level, moving in lockstep roughly 60% of the time. Yet in 1995, when just 16% of U.S. stock funds beat the S&P 500, correlations were considerably below their long-term average, according to Birinyi Associates.
In short, correlations aren’t correlated to outperformance by stock pickers. It’s just another crybaby argument trotted out by fund managers to explain why those big bad index funds are beating up on them again. With only 17% of actively managed stock funds beating the S&P 500 so far this year, according to Morningstar, it’s no wonder so many stock pickers are pointing their fingers at correlation as the culprit for their lousy performance. But that doesn’t mean you have to believe them.