Correlations close the week at .65 (increasing .14 week over week) with the vix closing at 18.84. Correlations at .65 is the 58th percentile for the past 15 years. While the past week of returns may have seemed extreme, that is only because we have been living in a low correlation and thus low volatility regime since early October (shown in purple box) – but we are effectively now in a *normal* price return environment.
On a short term basis that is absolutely true with correlations and volatility spreads on a 3 month basis at their 100 percentile mark with 6 month spreads ranks now far behind.
Last week we mentioned we would like to see correlations to be in the .85-1 range to have a durable intermediate term low. We believe as of now there is evidence of a short term low in place. We like to track transactional liquidity as it helps us get a sense of market internals. One way we do this is by using a modified Amihud Illiquidity ratio. Amihud defines liquidity as the price change in % per unit of volume traded. In his original paper* Yakov tracks this ratio for every single S&P500 stock to come up with a composite score. In our chart below we take a slightly different methodology using a 50 day percentile rank of the ratio. Illiquidity is defined as large price movements for relatively low volume traded. Across each of the S&P500 stocks this will effectively tell you whether bid-ask spreads are widening intraday. If you look at a volume bar for the SPY you will notice very high volume on Friday – at least the highest late December – and then before that October. Our ratio on the hand tells you that there was relatively low volume traded compared to the price change that occurred – within the S&P500 stocks – a reading >= the 99th percentile on a 50 day rolling basis. The chart below shows similar events – the metric more often identifies short term bottoms than not – just keep in mind the left tail.
While we would still like to see higher correlations for a durable intermediate term bottom – that generally precedes some sort of panic. We have not see that yet.
Have a great trading week ahead and as always we will update you will anything new that may change our views.
*Yakov’s Original Paper on Illiquidity: