The last two weeks have been anything but boring. For a brief moment, it looked like a combination of China and Greece might very well pull us over the edge. During this period the VIX swung from 16 to 20 then down to 12. At one point last week the VVIX, or volatility of volatility, briefly touched 110 which marks its highest level since January of this year. As we have harped upon in the past, spikes in VVIX represent periods where traders are revising their estimates at a rapid rate and thus can’t even trust their own perception of the market. Our trader’s intuition says we shouldn’t be surprised to see wild swings from lows to highs in this kind of environment, but this is a hypothesis we should test in short order.
In the meantime, we wanted to present a more detailed picture of correlation during this turbulent time. Thus we have produced our first Minimum Spanning Tree created from intraday data: 1-minute log-changes over the two weeks from 7/2/2015 to 7/16/2015. You can take an in-depth exploration of this tree for yourself by downloading SliceMatrix.
Each graph plots components of the S&P 500. The bigger a node, the more connected it is to the rest of the network. The thicker an edge between two nodes, the greater the correlation between the stocks at each node. The color of each node is colored using a red to blue to green colormap where bright red means the stock’s return was negative, blue is unchanged, and green is up. The edge color is a blend of node colors.
The most important stock by some margin is Marsh & McLennan Companies (MMC) which shares 55 connections to other stocks in the S&P 500 index. It is important to remember that this chart was generated from a correlation filtering algorithm, not subjective tags like industry classifications. Thus it is important we understand MMC’s business model so as to properly interpret the fact that so many other stocks fall within its sphere of influence. Here’s MMC’s business summary (emphasis ours):
Marsh & McLennan Companies, Inc., a professional services firm, provides advice and solutions primarily in the areas of risk, strategy, and people worldwide. It operates in two segments, Risk and Insurance Services; and Consulting. The Risk and Insurance Services segment offers risk management services, such as risk advice, risk transfer, risk control, and mitigation solutions, as well as insurance, reinsurance broking, catastrophe and financial modeling services, and related advisory services… The Consulting segment offers health, retirement, talent, and investments consulting services and products; and specialized management, and economic and brand consulting services…
MMC is strongly connected to insurance company MetLife (MET) with an intraday 1-minute correlation of 80%, which in turn is connected via correlation to Nucor (NUE), a producer of steel. At first the connection between a financial services firm and a steelmaker might seem odd, or at least not very intuitive. Investigation of the two time series, however, shows a similar factor could be driving the action in both stocks (subject to tradable idiosyncratic shocks):
The intraday correlation between NUE and MET is close to 70%. What could be causing such a high correlation? Perhaps insurance and steel-making are more deeply linked than appear at first glance. Further investigation is warranted, but when you think about it, the two products are highly cyclical and levered to the health of the overall economy. Both the creation of new businesses and the expansion of existing ones leads to an increase in marginal demand for both insurance and steel products.
Following along the chain, NUE is connected to ConocoPhilips (COP) an Oil & Gas exploration company. This connection makes more intuitive sense as both business model’s rely on natural resources, which may themselves be highly correlated. COP, in turn, serves as a local hub within the graph. It is connected to many other Oil & Gas companies such as Schlumberger (SLB) and Noble Energy (NBL), to name a few:
Traversing a different branch of the network emanating from MMC takes us to other local hubs like cruise-line operator Carnival Corp (CCL) and 3M Corp (MMM).
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