Moving in Lockstep
Each day the market is open, we have software that beautifully displays a list of ticker symbols and provides their real-time price quotes and percentage changes from the prior day – if a stock is down, the numbers are shown in red (my brother Steve refers to these as “Tomorrow’s Heroes”), if a stock is up, the numbers are shown in green (he refers to these as “Yesterday’s Losers”). For much of the year, it seemed on any given day we would either see everything on our list in green, or a sea of red, but no mixture of the two.
This correlation between stocks is often measured using the CBOE S&P 500 Implied Correlation Index which uses options prices to measure the correlation between the 50 largest stocks within the S&P 500. A reading of 100 would imply stocks are moving in lockstep, whereas a reading of zero would imply no relationship. During the panic at the end of 2008 and beginning of 2009, readings actually surpassed 100, compared to the typical 40 to 60 range seen during “normal” periods when stocks’ price movement behavior is based more upon the individual merits of a company. Most of last year this measurement remained elevated north of 60, and sometimes spiked above 90, and stands near 80 today. There was this macroeconomic or systemic feeling permeating the industry on the belief that “everything hinges on Europe,” and with the fear that “everything gets wet in a hurricane.”
In a type of environment where all stocks seem to move in concert, most would assume “stock pickers” would have a difficult time proving their worth. However, over time, the stream of cash flows a business distributes will eventually determine the value of a stock. As this unified behavior continues, it reminds me of an analogy my Father loves to use. He says to imagine depressed stock prices as beach balls being pushed underwater. The water level is the intrinsic value of the business. If the water level is rising, then the pressure is building on the stock price. Eventually, the hands will release and the stock will pop to the surface. So, if we have done our job correctly, the stock prices of the businesses we own will eventually separate themselves from other businesses and “swim against this correlation tide.”
Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.