One of the features of the stock market lately is that stocks tend to move in unison. On a given day when the stock market goes up, it seems like almost every stock is buoyed in price. On the other hand, if the market has a bad day, then everything seems to do down.
Above is a snapshot of the day’s results from Friday, February 6, 2009. You can see that every single stock in portfolio one and portfolio two increased in value during the day (portfolio three has a subset of the same stocks as portfolio two, so showing it was redundant for the point I was trying to make).
The covariance in the market is far more pronounced than it used to be in the past. This may be linked to the fact that the market is making more large percentage moves on a given day. Per Harper’s magazine February issue:
Number of times in 2008 that the S&P 500 closed up or down 5 percent in a single day: 17
Number of times between 1956 and 2007 it did this: 17
The fact that the stocks tend to move in unison makes selecting individual stocks more difficult. When you are selecting an individual stock, you are generally doing analysis on the performance prospects of that unique company. However, the fact that market moves are pushing all stocks in one direction or another (unfortunately, they have been mostly downward) no matter what the rationale for your stock may be, it is buried by the overall market moves.
Some items logically cause the entire market to move on a GIVEN day – for example, this day the market was up primarily due to the fact that the stimulus package appeared to be resolved. Other factors, like changes in interest rates, can make equities more or less valuable overall because they are often an alternative to debt instruments. As the interest rates rise, debt instruments become more attractive and stocks less attractive, all else being equal. Items like attacks on the US or foreign countries can also cause one-day (or longer) shocks to the market, or increase “systemic risk”.
In any case, covariance is definitely increasing, meaning that more and more of the return on an individual stock is due to what is happening across the entire market and less and less due to the story of a particular company. Nowadays company specific research should mainly focus on the downside risk – companies that have to refinance debt at unfavorable rates, for example, which could cause their value to go to “bagel-land” or zero.