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Stockpicking Window Shuts as Market Correlation Rebounds

After a period of respite in the first quarter, rebounding correlation between equities is undermining the strategies of investors looking to make outsize returns by betting on individual stocks.

The CHART OF THE DAY shows, in the top panel, how the one-year correlation among eight benchmark share indexes has climbed since March. The monthly data was compiled by JPMorgan Chase & Co. The lower panel shows the connectedness among stocks in the Standard & Poor’s 500 Index, according to Morgan Stanley. The yellow lines indicate the average.

The tighter the link among stocks, the harder it is for investors to beat the market, and the less justified is the risk of going against the herd. A strategy that involves buying favored companies while short-selling others has gained 4.5 percent since the U.S. bull market began on March 9, 2009, according to Chicago-based Hedge Fund Research Inc. The S&P 500 has rallied 100 percent over the period.

“Correlations will edge higher,” Jose Gonzalez-Heres, a managing director at Morgan Stanley Investment Management, said in a phone interview on May 9. “This is leading us to favor more directional strategies such as macro and not so much stock-selection strategies. We are less confident that there will be a good market for stock-pickers.” His company oversees about $287 billion globally.

Gonzalez-Heres, a manager at Morgan Stanley’s Alternative Investment Partners division in West Conshohocken, Pennsylvania, authored an essay in the Spring 2012 issue of The Journal of Wealth Management called “The Effect of S&P 500 Correlation on Hedge Fund Alpha,” which concluded that times of high correlation are unfavorable for stock selection.

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