Sudip Bandyopadhyay’s Blog

The stockbroker’s lexicon is full of euphemisms. One of the more insidious is “a stock-pickers’ market”. The positive spin on such a market is that there are returns on offer for those who pick the right stocks. A more realistic take is that the market as a whole is doing nothing - but you might just get by if you are lucky enough to pick the right stocks.

At present, a stockpickers’ market, in either sense of the phrase, would be a boon. Last calendar year was one of the most spectacular cases on record, when trying to pick the right stocks would have made little or no difference. Returns for the two traditional main styles of investing - “value” investing focused on stocks that are cheap compared to their fundamental value, and “growth” investing focused on stocks whose profits are growing - were virtually identical and, of course, not satisfactory.

There was also barely any difference between the performance of larger and smaller companies. Even differences based on geography were minimal. Huge currency movements during 2008 ensured some variation, but a look at the performance of the main indices in North America, Western Europe and the developed markets of Asia showed that they all moved in line with each other. All of this can readily be explained. Last calendar year, unjustified optimism about the world economy turned to something more realistic in mid-summer, and then to something much worse after equity investors were taken by surprise by the financial crisis that followed the fall of Lehman Brothers.

From summer onwards, correlation between stocks rose to virtually unprecedented levels. Correlation tends to move in line with volatility, which also reached levels unseen even in the Great Crash of the early 1930s. According to David Kostin of Goldman Sachs, the average correlation of the stocks in the US S&P 500 index reached 66 per cent by the end of the year, by far the highest in two decades, while correlations within economic sectors were even higher. And correlation between economic sectors, even though they should be affected very differently by a recession, is at its highest in more than 20 years.

Put simply, the “top-down” or “macro” bad news on the economy swamped any “bottom-up” or “micro” news that might have helped to differentiate companies. Instead, everyone sank together. Picking stocks became an irrelevant skill. It is fair to assume that macro factors will drown out anything micro for a while. There will be intense interest in the government spending plans across the world, in central banks, and in any signs that deflation is turning to inflation. But once markets have stabilised a little, correlations should come down. That does not necessarily imply a surge in broad indices; but it should mean that stock-pickers can make some money. After a sell-off so indiscriminate, some companies must now be badly undervalued compared to their peers