Examining the Breakdown in Sector Correlation

by: , Portfolio Strategist, MainStay Investments

In the 90 years since 1928, 2017 has recorded the second lowest volatility on record for the S&P 500, bested only by 1964. The calm at the surface, however, belies somewhat greater turbulence beneath.

S&P 500 COMPOSITE 6.54%
S&P 500 ES CONSUMER STAPLES 7.48%
S&P 500 ES CONSUMER DISCRETIONARY 7.83%
S&P 500 ES HEALTH CARE 8.46%
S&P 500 ES INDUSTRIALS 8.94%
S&P 500 ES REAL ESTATE 9.31%
S&P 500 ES UTILITIES 9.65%
S&P 500 ES MATERIALS 10.31%
S&P 500 ES INFO TECHNOLOGY 10.91%
S&P 500 ES FINANCIALS 12.59%
S&P 500 ES ENERGY 12.89%
S&P 500 ES TELECOM SERVICES 14.71%

Sources: Bloomberg, NYLIM, as of 12/30/2017. Index definitions found at the end of this post. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index.

Index level volatility is mild, despite higher readings at the sector, due to intersectoral correlations – a measure of the degree to which industries in the benchmark S&P 500 Index trade independently of one another – being near the lowest in almost 30 years.

Sector Correlations Hit Multi-Decade Lows

Source: Thomson Reuters Datastream, as of 12/30/17.

One possible contributor to the breakdown in sector correlation was the shifting expectations for policy change out of Washington. As the likelihood of tax cuts, health care reform, trade agreement renegotiation, and infrastructure spending waxed and waned, potential winning and losing sectors moved in opposite directions.

Why Does It Matter?

There are two notable features of a low-volatility, low-correlation environment such as this. First, with volatility low at the index level, investors may be more inclined to take on additional risk. And second, low-sector correlations may promote performance chasing. Both can end badly.

Now, as always, disciplined portfolio construction is paramount. Investors should ensure their portfolio is prudently balanced across asset classes to suit individual circumstances, investment aims, and risk attitudes. Likewise, it is essential to maintain diversification across industries, protecting against the vagaries of unexpected policy developments, technological changes, and evolving global economic conditions.

A new year can serve as a useful reminder to rebalance your portfolio, if you haven’t already.

Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.

About Risk

All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.

The S&P 500 Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock market performance.

The S&P 500 Consumer Staples Index comprises those companies included in the S&P 500 that are classified as members of the GICS® consumer staples sector.

The S&P 500 Consumer Discretionary Index comprises those companies included in the S&P 500 that are classified as members of the GICS® consumer discretionary sector.

The S&P 500 Health Care Index comprises those companies included in the S&P 500 that are classified as members of the GICS® health care sector.

The S&P 500 Industrials Index comprises those companies included in the S&P 500 that are classified as members of the GICS® industrials sector.

The S&P 500 Real Estate Index comprises stocks included in the S&P 500 that are classified as members of the GICS® real estate sector.

The S&P 500 Utilities Index comprises those companies included in the S&P 500 that are classified as members of the GICS® utilities sector.

The S&P 500 Materials Index comprises those companies included in the S&P 500 that are classified as members of the GICS® materials sector.

The S&P 500 Information Technology Index comprises those companies included in the S&P 500 that are classified as members of the GICS® information technology sector.

The S&P 500 Financials Index comprises those companies included in the S&P 500 that are classified as members of the GICS® financials sector.

The S&P 500 Energy Index comprises those companies included in the S&P 500 that are classified as members of the GICS® energy sector.

The S&P 500 Telecommunication Services Index comprises those companies included in the S&P 500 that are classified as members of the GICS® telecommunication services sector.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.

1760770

Robert Serenbetz

Portfolio Strategist, MainStay Investments

Robert Serenbetz is the Portfolio Strategist for the Strategic Asset Allocation & Solutions Group (SAS). He contributes to investment thought leadership and communication efforts across New York Life Investment Management

Full Bio

Leave a Reply

Your e-mail address will not be published.