ETFs take over from individual stock picking

The correlation of S&P 500 members to daily move in the benchmark overall has been steadily rising toward parity over the last 10 years, a sign that exchange-traded funds, electronic trading and a short-term mentality is slowly killing individual stock picking based on fundamentals.

"We’ve gotta ask ourselves what’s more important,” said Gary Kaminsky, former money manager for Neuberger Berman and currently contributing editor for CNBC. “Earnings or just getting into the index club?"

Birinyi Associates, the research firm founded by legendary trader Laszlo Birinyi, took the daily change of the 500 members of the index and compared them to the daily change in the index itself over a rolling 200-day period. Ten years ago, stocks moved more independently at a 0.3 correlation. Today, the correlation is approaching the 0.7 mark, which basically means that 70 percent of the time, an individual stock’s move will match the change in the overall index each day.

"If I had to hypothesize, it is the proliferation of ETFs,” said Cleve Rueckert, the Birinyi analyst who compiled the figures. “You’re getting less specific company analysis and more of a focus on sectors."

The analyst also cited a short-term trading mentality that is feeding on itself. Rueckert gave the example of traders selling Exxon lower on BP’s Gulf of Mexico spill just because it is ain the same sector, even though it may turn out over the long run that Exxon actually benefits from BP’s woes.

However, this shorter mindset is understandable given this year’s so-called flash crash and essentially a lost decade of zero return for equities.

Kaminsky goes one step further and blames “closet indexers” as well. Essentially fund managers are buying the S&P 500 member companies blindly so they don’t fall behind the rest of the pack and lose their job.

Computer trading may also be to blame, investors and analysts said. Doug Kass of Seabreeze Partners estimated in May that 70 percent of the day’s activity can be tied back to high frequency trading by hedge funds and banks.

Cerner (CERN), a maker of health care information technology, is the latest stock to be added to the S&P 500, getting the nod at the end of April.

Congratulations Cerner. You can relax now. You made it into the club.

For the best market insight, catch ‘Fast Money’ each night at 5pm ET on CNBC. 

Ref: http://www.cnbc.com/id/37779816

John Melloy is the Executive Producer of Fast Money. Before joining CNBC, he was an editor for Bloomberg News, overseeing the U.S. Stock Market coverage team

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