Analysis on Correlation to S&P 500 vs. Returns

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The question I had was whether a stock within the SP500 will have a high probability of returns if it had a higher correlation to the index as a whole. Though it seems like an obvious answer since the SP500 has been growing consistent every year, I wanted to check how strong would the correlation have to be and whether if all sectors behaved the same.

Another key question was whether if the index was fragmented with stocks distributed in it’s correlation or was it mainly centralized with most stocks having a strong correlation to the index.

Few caveats here in terms of data. I’ve only used the current list of SP500 and did not adjust back historically. Also the analysis ran a correlation on daily close prices between 2008 to 2021. For stocks that don’t have history from 2008, I took it’s earliest point as long the stock had at least 5 years of history.

The Index as a Whole

3 key insights at the index level. (1) Stocks that were weakly correlated to the index grew at a slower rate than stocks who were strongly correlated to the market. (2) Only stocks with correlation values over 0.9 had outsized returns and (3) Correlation is a poor predictor for returns

Majority of the index is composed of stocks that are highly correlated to the index. Stocks that were weak or negative only accounted for ~17% of the index.

At the Sector Level

If you’re interested in the above charts at the sector level, I’ll provide them below. For the most part, the sectors follow the same pattern.

When looking at the CAGR returns, no surprise here as the IT sector and Consumer Discretionary sector had the most concentration of stocks that had outsized returns vs. the index. This was reviewed in my previous analysis: Probability of Beating the SP500 Index

The only sector that’s interesting when breaking out the count of stocks by correlation is energy because it’s the sector that has the most concentration of weak and negative correlated stocks.


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