A recent Goldman Sachs study has garnered a lot of attention. They found that the 3-month average stock correlation in the S&P 500 has fallen to 0.17, the lowest level since 2017. To compare: during the pandemic, this number once reached 0.75-0.80. Now it’s actually only 0.17, what does that mean?

On the surface, this seems to reflect market diversification. But the reality is much more complex. What is the truth? Seven tech giants account for over 40% of the total market cap of the S&P 500, and they are soaring. Meanwhile, BlackRock’s data shows that about 40% of S&P 500 components will lose money in 2025. In other words, only a few stocks are making money, while most are fighting on their own. This is not a healthy market structure but an extreme divergence — correlations have been pushed to historically low levels.

Even more concerning are the signals from history. What happened after correlations hit lows in 2017? Market volatility surged in 2018. And after the low correlation in 2019? In 2020, during the pandemic, a 34% crash caused correlations to spike to 0.80. These shifts often happen within a few weeks. Kieran Diamond, a derivatives strategist at UBS, bluntly states: implied correlations have fallen to historic lows, and once macroeconomic factors regain control, the VIX could soar significantly.

There’s also something even more dangerous called the "Correlation Bomb." It sounds like jargon, but the concept is simple. Many hedge funds are playing the same game: buying individual stock volatility, selling index volatility, betting on low correlation to continue. A San Francisco volatility fund, QVR Advisors, has already noticed the signs: diversified trading has become an overcrowded strategy. They are even starting to short this strategy inversely.

What happens if a systemic shock occurs? For example, an AI bubble burst, tariffs are actually implemented, corporate earnings fall short — any of these could cause correlations to jump from 0.17 to above 0.60. What then? All diversified trades would lose simultaneously, triggering chain liquidations, and correlations and the VIX would rise further. This is what’s called a "bomb."

There’s also a more unsettling discovery. Research from LVW Advisors reveals a paradox: when market concentration is high (corresponding to low stock correlations), the correlation between stocks and bonds actually increases. What does this mean? The traditional 60/40 portfolio (60% stocks, 40% bonds) becomes less effective at diversification.

Looking ahead to 2026, the outlook is straightforward: increased volatility will raise the correlation between stocks and bonds. When a crisis hits, stocks and bonds will fall together, and those who thought they were diversified will face the harsh truth — their portfolios are actually extremely fragile.

Data speaks. History shows that when correlation shifts from very low to very high levels, the S&P 500 typically crashes 15-30%. And this transition often occurs within a few weeks. So, the current 0.17 looks very safe, but the next move could come faster than you think.