Are ETFs Responsible for Rising Market Correlations?

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originally published at ETFTrends

S&P 500 stocks are moving as a herd and the increased presence of exchange traded funds in financial markets may be partly responsible for the spike in correlations, according to a report Monday.

Stocks in the S&P 500 over the past month have a correlation of 80%, higher than the peak reached during the financial crisis in late 2008, The Wall Street Journal reported.

“One potential reason is the popularity of exchange traded funds. ETFs account for more than 30% of volume in U.S. stock markets, compared with just 2% in 2000,” the newspaper said. “It’s reasonable to expect ETF trading to drive correlation higher because many of the vehicles are tied to stock indexes.”

The three-month stock correlation in the S&P 500 is the highest in at least the past 20 years, while sector correlation is also elevated, according to a recent note from Goldman Sachs analysts.

A higher correlation means prices are moving together, rather than going their separate ways. [Sector ETF Correlations at Two-Year High: Strategist]

Correlations have spiked recently amid the so-called risk-on and risk-off trades. High correlations are not indicative of a healthy or normal market, analysts say. [Rising Correlations]

“Elevated correlation is generally considered a poor environment for long-only fundamental investors,” Goldman Sachs said.

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