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New data shows stock pickers' market ahead

Wednesday, 14 Aug 2013 | 6:00 AM ET
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Lower market correlations and the resulting better climate for stock pickers could mean a healthier market—though getting from here to there might mean a rough road.

Amid all the enthusiasm over the ferocious 2013 stock market rally, one theme has gone under the radar.

The tendency of all stocks and even most asset classes to move in sync has reached multiyear lows, suspending the "risk-on, risk-off" trade where either everything was rising or everything was falling.

Not surprisingly, active managers have begun to see better performance, and hedge funds had a stunningly positive July.

Markets off worst week in 2 months
Savita Subramanian, Bank of America Merrill Lynch, has a price target of 1750 on the S&P 500 by the end of the year.

(Read more: Hedge funds are back: 70% see positive July returns)

Investors trying to keep diversified portfolios—balancing domestic and foreign markets, or buying sectors that usually move opposite each other—have an easier time in such an environment.

The question, of course, is whether it can last.

"It could all just be a fluke," Nicholas Colas, chief market strategist at ConvergEx, said in an analysis of the recent trends.

"We've had plenty of head fakes of various types in the last five years which seemed to portend a return to more normal macroeconomic and market routines," he said. "While the data is very welcome, it would be wise to take it with a grain of salt until we see these trends hold."

(Read more: Almost everyone is misreading Fed's new QE study)

Colas compiled a compelling set of data to illustrate how pronounced the anticorrelation trader has become:

The 10 individual S&P 500 sectors are at their lowest correlation to the index in years—at 70 percent in July from 89 percent the previous month. Tech is at 58 percent and the utilities group is at 47 percent.

High-yield bonds—often seen as a proxy for broad market movement—are now only 16 percent correlated to U.S. stocks, after hitting 67 percent in the most recent three-month period.

Emerging and developed international markets are now showing respective correlations of 58 percent and 76 percent, down from 80 percent.

Precious metals are at just 5 percent for silver and 15 percent for gold.

The Australian dollar has tumbled all the way from a 73 percent correlation to 11 percent

Colas pointed out that 50 percent correlations had been around the norm prior to the financial crisis that began in 2008.

The reason could have to do with Federal Reserve policy.

With the central bank indicating that it is preparing to ease back on its monthly bond purchases under its quantitative easing program, Colas said investors are beginning to adjust their expectations.

(Read more: Too early to say on tapering: Lockhart)

Rather than watch a market that is rising in unison based on Fed liquidity, investors may start picking "winners and losers on fundamentals," he said.

"This would be welcome news to everyone from stock-picking analysts and portfolio managers to individual investors," he said.

(Read more: 'Fully priced and then some': Market break time?)

"Lower correlations means more capital can flow into asset markets around the world and maintain the same levels of risk," he added. "That is also profoundly good news for brokers, asset managers and other businesses which need incremental volumes to generate earnings growth."

Whether it continues will rest on several factors, including continued economic growth and predictable central bank policy.

Should any of the factors break down and correlation returns, diversification goes back out the window and passive management rules.

"This is not the way global stock and bond markets are supposed to work. The bedrock of all academic research into the behavior of capital markets rests on the value and power of diversification," Colas said of high correlations. "If all (asset classes) move similarly, as they have for over half a decade, then there is simply less reason to put money to work."

_ By CNBC's Jeff Cox. Follow him @JeffCoxCNBCcom on Twitter.

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