Sector Divergences in a Less Correlated World

In 2008, decoupling will likely apply not only to the global economy picture (as noted in yesterday’s blog posting) but also to the recent high correlations between and among asset classes. Until recently, some of the most notable examples of high correlations have been in the economic sectors (see blog postings for previous correlations, particularly the July 11, 2007 posting).

This year, however, there’s a very good chance that correlations will diminish.

As the above chart from investment strategist extraordinaire, Tom McManus, shows the variance between sectors has begun to rise.

Investment Strategy Implications

Since starting this blog back in March of last year, I have noted correlations 10 times. Each time, the references have been toward the trend that was in place – higher correlations. With the advent of the credit crisis last summer, the trend toward lower correlations has become apparent. Gold, for example, was once highly correlated to the equity markets, even though logic dictates it shouldn’t be. Clearly, something has changed and that change is producing a divergence that has already manifested itself in not only Gold but also in weak trending economic sectors such as Financials and Consumer Discretionary.

Hedge funds and 130/30 managers will likely contribute to the trend toward lower correlations. Alpha seeking among a more seasoned and aggressive growth of credit fiasco survivors coupled with momentum investing should be key factors in bringing about a greater divergence between and among asset classes and sectors.

As a result, momentum investing, a key component of many investment professionals' preferences, in 2008 will likely become more concentrated as hedge fund managers and more aggressive 130/30 mutual fund managers seek to segment the sectors and styles, the regions and countries that the global growth story provides.

So, here’s a little investment rhyme that should play out this year:

The strong get stronger,
The weak will fade.
All gets overdone,
There’s money to be made.