The one sport in the Olympics that never ceases to amaze me when I see it is synchronized swimming, also known as water ballet. The way the athletes bob and weave through the water so effortlessly is pretty astonishing. I think it’s one of the most underrated shows of athletic strength in the Olympics—to move together like that in almost perfect harmony must take a lot of strength.

But while moving together in lockstep is a sign of strength for an Olympic swimmer, it’s less so the case for the stock market.

For an athlete, moving together is called synchronized; in the stock market, we call it correlation—and that’s what our chart above measures.

Specifically, it shows the median 63-day correlation of S&P 500 stocks to the S&P 500 index. In other words, we take all 500 stocks in the S&P 500 index and calculate the correlation of their 1-day returns with the whole index itself (for the past 63 days, or 3 months). We then take the median (or middle) correlation and use it as the basis for the indicator. This gives us a good sense of how the average stock in the index is moving in relation to the overall market.

We consider correlations to be rising when the indicator increases by 0.05 points and falling when it declines by 0.05 points. Interestingly, we find that most of the gains in the S&P 500 have come when correlations are falling—as the S&P 500 has historically gained around 11.7% per year, on average, when this is the case. When correlations are rising, however, the gains have been much lower—about 4.5%, on average.

Earlier this year, we pointed out that correlations were still falling from the high reached during the March 2020 selloff and that it was a good sign for stock returns. Indeed, the S&P 500 stock index has done well this year.

However, things are looking less certain today. The indicator has risen more than 0.05 points from a recent low, triggering a sell signal for the S&P 500 index. The key test will be the high reached in August. If correlations continue to rise from here and blow past that level, it could be a sign of increasing fear among investors, as they potentially sell stocks indiscriminately regardless of any underlying value. Based on the history of this indicator, we would expect more muted returns for the stock market in times like that.

 

This is intended for informational purposes only and should not be used as the primary basis for an investment decision.  Consult an advisor for your personal situation.

Indices mentioned are unmanaged, do not incur fees, and cannot be invested into directly.

Past performance does not guarantee future results.