Monday, September 22, 2014

Sector Correlations in the Stock Market and What They're Telling Us

Here is a chart of rolling 20-day correlations within sectors specific to SPX stocks, as highlighted in the recent post.  What you can see is that the sectors have become less correlated over the past year, but there have been meaningful swings higher and lower.  Specifically, we've seen correlations bump up when stocks have sold off and we've seen the lowest correlations during periods of market topping.  As mentioned in the prior post, low correlation markets have tended to produce flat returns in SPY during the recent bull market; superior returns have been achieved by buying relatively high correlation markets.

We can see from the chart above that we have recently seen unusually low levels of correlation, which have trended higher in the past few sessions.  Along with the failing breadth, this is consistent with a topping phase of a market cycle

Further Reading:  Correlations and Opportunity Sets in Markets