Correlation and Dispersion: Return of the Stock Picker's Market?
Amid normalizing central bank policy, correlations and dispersion are trending in a favorable direction for fundamental investors.
Even for the most skilled equity portfolio managers, high correlations and low dispersion can be an unhealthy mix. If returns for individual securities move in the same direction (high correlation) and at a similar magnitude (low dispersion), there will be limited opportunity to beat the market. We’ve seen this in practice in recent years, as a range of factors, including unconventional global monetary policy, the lingering effects of the global financial crisis (GFC), and flows into ETFs and passive investments, have created headwinds for active equity strategies.
But recently, amid growing indications of normalization in central bank policy, we have seen signs that correlations and dispersion are trending in a favorable direction for fundamental investors. In this paper, we consider these trends and some of the conditions that could help them endure.
All investments are subject to risk, including the possible loss of principal. Foreign investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as political and economic developments in foreign countries and regions.