The CBOE Correlation Index (KCJ) is close to the lowest level we have seen since it was first listed in 2007. The KCJ measures the implied movement of the S&P 500 components options, compared to the implied movement of the S&P 500 index options. Simply put, the higher the number, the more likely all stocks are going to move together. Conversely, a low number will be characterized by sector rotation, and flat markets; one sector moves higher, another moves lower.
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Correlation, for lack of a better term, is correlated with volatility. Not surprisingly, 30-day S&P 500 historical volatility is near the low level of 6.5%. Currently at 33.5, KCJ is sitting close to rock bottom, lower than where it was in 2007, (but not lower than where Lindsay Lohan was in 2007).
So far this year, the market has been able to grind higher, characterized by leadership in FANG(Facebook Apple/Amazon, Netflix, Google) and sector rotation. As the summer hit, FANG has slowed with GOOGL and AMZN hitting psychological barriers of $1000. Without this leadership, the market has been flat lining since. In addition to FANG losing steam, the FED, for its part, would like to throw cold water on the market, worried that stocks are forming a bubble.
Yesterday, we heard comments from FOMC chairwoman, Janet Yellen, who stated that asset prices are, “somewhat rich if you use some traditional metrics like price earnings ratios.” We saw Asian and European markets lower overnight, however the U.S. market has been resilient in defying the FED, once again saved by low correlation. Sector rotation this year, again, for lack of a better term, has rotated. Last week, the market rotated out of tech and into health care stocks. This week, we are seeing the market rotate into financials.
Volatility indicators, for lack of a better term (somebody stop me please), are volatile; the VIX especially so when it’s at these extreme lows. The KCJ might go back to normal by next week, or it might stay low and go even lower this year. It’s easy to look at this index and conclude that since this pattern of low correlation happened last in 2007, then it must mean we are due for a 2008 type of Lindsay Lohan meltdown. That is a lazy conclusion. Yes, we can correlate low correlations with low volatility. However, no one stock market indicator should be treated like a Nostradamus prophecy. The best use of this indicator, like so many others, is to be mindful of it while also being mindful of all the other factors that influence the supply and demand of asset prices.