US equities are beginning to behave more normally. The average pairwise correlation across
S&P 500 stocks has plunged (top-left chart), which tells us that stocks are starting to move
independently from one another and are no longer driven to the same extent by the Fed. We had
seen early signs of this in early June when we saw a short-lived reversal in tech outperformance
and a rebound in beaten-up names, but recent moves show a much clearer trend. The
continuing collapse of real yields as well as Q2’s earnings explain this shift. Investors are refocusing
on valuations and are trying to front-run the economic recovery by rotating towards
more lagging, cyclical sectors (as we have been advising).

Implied correlations from individual mega-cap stock options suggest that this trend is likely
to continue (bottom-left chart). It is unusual to see low implied correlations accompanied by
an elevated VIX. This is likely due to the VIX being used to hedge more, and suggests that
correlations are sensitive to moving higher again. Still, though, stock picking is not easy, with the
distribution of valuations almost back to where it was on the February 19th high, and the median
P/E higher (last chart).

Source: Bloomberg, Macrobond and Variant Perception