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Global Stocks Move in Unison On Fears of New Credit Crisis

Whether you are an investor based in New York, Rio de Janeiro or Paris, it doesn’t matter which stock you pick. They are all going in the same direction in nearly perfect lockstep.

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The reason: growing worries that a Greek default will spark another global financial crisis, where access to funding trumps any individual merits of companies.

“The difference between investing in emerging markets equities, developed markets equities and high yield bonds is now effectively zero,” said Nicholas Colas, chief market strategist at ConvergEx Group in a note to clients. “The only reason it won’t matter whether you own utility stocks or tech stocks or health care stocks is if the world’s major banks can’t open for business the next day.”

The average correlation between the 10 major sectors in the S&P 500 – from financials to energy – is at a mind boggling 97 percent, up from 82 percent three months ago and matching levels during the depths of the 2008 financial crisis, according to the ConvergEx research team. Every sector, including utilities, has a correlation above 90 percent with the benchmark.

Developed markets outside of the U.S. – as measured by the MSCI EAFE Index – have a 96 percent correlation against the S&P 500 index. Emerging markets – as measured by the iShares MSCI Emerging Markets ETF – are 97 percent correlated to the U.S. market. High yield corporate bonds move in the same direction of the S&P 500 index 89 percent of the time.

“If you want to diversify in a dangerous, highly-correlated market, you have two choices: shift asset allocation more into cash or use option strategies,” advised Alec Levine, an equity derivatives strategist at Newedge group.

Global stocks recovered together on Tuesday after German Chancellor Angela Merkel hinted that a Greek default was not an option. Investors fear that a default could trigger big losses for exposed European banks such as BNP Paribas and Societe Generale and dry up access to capital for companies worldwide like what happened after the Lehman Brothers collapse in 2008.

This correlation phenomenon is killing the returns of hedge funds that are supposed to thrive in difficult markets by going long certain stock and short others. Long/short hedge funds have a negative 3 percent return on the year, on average, after four straight months of negative returns, according to figures from research firm BarclayHedge.

“Macro trumps everything so given that most stocks seem to be correlated to the macro outlook, they then are therefore correlated to each other,” said Karen Finerman, president of Metropolitan Capital Advisors. Finerman’s hedge fund, which tends to have a more long-term focus, is using this time to pick stocks that will outperform when this trend finally breaks. She’s also buying protection in the form of put options on the S&P 500.

But don’t look for this trend to change anytime soon. The CBOE S&P 500 Implied Correlation Index, a measure “of the expected average correlation of price returns of S&P 500 Index components” according to the exchange’s web site, is near its highest ever. It was created by the exchange in July 2009.

“If the basic thesis here is correct – that correlations will stay high as long as markets are worried about solvency more than individual stock fundamentals – then we provably have several more months of lock-step price action,” wrote ConvergEx’s Colas.

On the bright side, gold and silver are back to providing true diversification these days. They have been uncorrelated in the last month with the S&P 500, unlike during the Lehman crisis when they fell with stocks as hedge funds sold holdings of the metals to raise cash

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