CITI: Stock Market Correlations Have Collapsed To A Level That Puts Us At Risk For A Correction

It looks at the correlation of the 50 largest stocks in the S&P 500. This is the degree to which these stocks move with each other.

The fact that correlations have collapsed recently may be a warning sign for investors.

Here's Levkovich (emphasis added):

Intra-stock correlation of the top 50 market cap names has plunged in the past month. Investors look to be at risk given the collapse of intra-stock correlation from 66% at the end of June to just 18% at the month's end in July which suggests that investors might be overly focused on stock picking and have begun to ignore broader influences such as Fed policy, market valuation, European growth trends, economic surprise indices and the like. Very high readings on intra-stock correlation tend to generate an intriguing buy signal as seen in September 2011, while low levels suggest a degree of complacency that puts fund managers at risk for a correction.

"Macro concerns should never dominate the discussion, but they should not stop mattering either," he added.

Levkovich also explained that some investors have felt the need to invest more aggressively in stock with high beta. But he thinks that now's the time to be dialing back risk.

"[I]investors might prefer large caps and less Diversified Financials exposure in the near term," he suggested.