Tuesday, January 6, 2015
We use this measure along with many others when looking for extremes in the market. While most of our indicators have yet to flash extreme readings they are getting closer and this chart is no exception. Below we're observing rolling 20-day sector correlation relative to the S&P 500 since 2012. As you can see, the current move lower in the market has coincided with a rapid move up in correlations across sectors. In fact, we've already exceeded the correlation high seen at the mid December lows. And going back to 2012, when these underlying sectors become highly correlated it has suggested that an intermediate market bottom is in the offing.
Treating extreme readings like this as potential inflection points has been a wonderful active trading strategy over the last few years. Simply put: buy weakness and sell strength. At some point the buy the dip strategy will not work as well as it recently has. However, with global liquidity still such a force it's possible this can continue on for much longer. Using these types of measures can be useful when looking for turning points in a reversion market.
Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.
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