It is a general rule in most investment markets that when “big events” occur – think, say, the onset of the global pandemic in March 2020 – all market participants tend to be highly correlated, i.e. all share prices fall together. When so-called “macro events” are less significant in moving markets, then share prices are driven by their individual circumstances e.g. growth in earnings, change in profit margins, increase or lessening of competition, management guidance, etc.
Source: MST Marquee
The chart above, from MST Marquee, a Sydney-based research house, shows how intra-market stock correlations (the light grey vertical lines) for the ASX 200 have sharply declined over recent months. The chart shows the average correlation for each stock in the index with all other constituents at the time. When correlations rise, there are only a few important drivers of stock prices and they tend to be macro. When correlations fall, there are disparate drivers of share prices and these are periods for stock-pickers. This means that macro events are tending to drive share prices less and less, and individual company circumstances are becoming more important in moving prices.
Last year, markets were far more concerned with the “big picture” macro drivers such as persistent inflation, tighter central bank policy, the collapse of the UK bond market and fears of a global recession. This year, the macro drivers have included the collapse of Credit Suisse, the US regional banking crisis, falling energy prices, a disappointing Chinese reopening recovery, and of course interest rate decisions by the RBA and other central banks. Nevertheless, it seems observable from the chart that whereas last year was about top-down, in 2023 it is more about bottom-up.
The chart shows that spikes in intra-market correlations since 1997 have been associated with major macro events. The month where Aussie stocks were most highly correlated was October 1997, during the depths of the Asian banking crisis, when investors rushed to sell stocks and the ASX 200 declined by 11% during the month. The second most correlated month was March 2020 — the initial COVID lockdown. The ASX 200 tumbled 21%. The third most macro month in the last 25 years was September 2022. This was the UK gilt crisis.
Since last year’s peak, intra-market correlations have declined. MST Marquee think that the broader trend from here will be lower intra-market correlations. Clusters of macro-months tend to occur around actual or perceived turning points in the profits cycle and their view is that we are in a mid-cycle slowdown, not an end-cycle collapse. They think that there is no major turning point for risk assets on the horizon.
Investors expecting markets to remain “less macro driven” should consider high quality stocks that have a good bottom-up investment case and rely less on top-down drivers like bond yields, currency and investment sentiment (risk-on/risk-off) to outperform.
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