U.S. Stock Market Sectors: Correlations

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Includes: SPY, XLE, XLF, XLI, XLK, XLP, XLU, XLY
by: Marius Bausys

Summary

Although 4 of 9 sectors have a correlation of 0.93-0.94 with S&P 500, no pair of individual sectors exceeds 0.87.

Utilities is by far the least correlated sector to all others.

The energy sector was less interconnected with the rest of the stocks in 2015 due to the turbulence in the commodities market.

In a separate article last week I briefly reviewed the performance of individual sectors in 2015. This time I would like to complement the original piece with a correlation analysis of the same 9 Select Sector SPDR ETFs. It is always a useful exercise to examine how the market is interlinked and hopefully this study will give readers some ideas how to diversify their portfolios more efficiently.

To obtain the estimates of correlation coefficients, I have used the online portfolio analysis tool InvestSpy. SPDR S&P 500 ETF (NYSEARCA:SPY) has been also included in the list as a proxy the broad U.S. stock market. Utilizing daily data from 2015, the results table looks as follows:

Click to enlarge

Source: InvestSpy

To make it easier interpret the output, here are the sectors each of the tickers corresponds to:

Ticker

Sector

XLY

Consumer Discretionary

XLP

Consumer Staples

XLE

Energy

XLF

Financials

XLV

Health Care

XLI

Industrials

XLB

Materials

XLK

Technology

XLU

Utilities

SPY

S&P 500 Index

Click to enlarge

Source: Select Sector SPDRs

Most correlated sectors

One interesting observation from the output matrix above is that no pair of individual sectors had a correlation coefficient of 0.90. The highest reading of 0.87 was recorded in two cases: Industrials (NYSEARCA:XLI) & Financials (NYSEARCA:XLF) and Industrials & Technology (NYSEARCA:XLK). Although there seems to be no apparent similarities between these sectors, the relatively close correlation between them can be explained by the broad market moves. XLI, XLF and XLK all have correlations of 0.93-0.94 with SPY, showcasing their close link to S&P 500 as a whole. Consumer Discretionary (NYSEARCA:XLY) could also be included in the same category as its co-movement is only immaterially less significant.

Least correlated sectors

Another thing that stands out from the numbers above is how little correlated to other sectors the Utilities (NYSEARCA:XLU) are. XLU had a correlation coefficient no greater than 0.50 with 7 out of 8 peers and only demonstrated a slightly closer link with Consumer Staples (NYSEARCA:XLP). Nonetheless, the independence of the utilities stocks from the reset of the market should not come as a big surprise. It is well know that the utilities sector encompasses features of both equity and fixed income securities, thus its correlation with other stocks is usually lower.

Another sector that was fairly independent in 2015 was the Energy (NYSEARCA:XLE). With commodities slumping across the board and oil price taking another 30%+ hit, the energy sector walked a path of its own, particularly in the second half of the year:

Click to enlarge

Source: Google Finance

However, historically XLE has been more correlated with the broader market and a reversion to the mean is almost certain when the outlook for the sector stabilizes. Of course, the big question is when exactly that is going to happen.

Conclusion

Although universal risk-on/risk-off forces tend to govern the markets, individual sectors are by no means identical and can still be utilized in the search for a better diversified portfolio. From the traditionally uncorrelated utilities to the temporarily displaced energy sector, there probably is a segment of the economy that can fit into your portfolio nicely.

Disclosure: I am/we are long SPY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.