Time to be Selective: Dispersion and Correlation of the S&P500 Today

Feb 09, 2018

Time to be Selective: Dispersion and Correlation of the S&P500 Today

You may read this weekend that correlations between US stocks have significantly risen this week. Currently, the realized correlations for S&P500 stocks sits at 0.47 vs a 1-year average of 0.19 and 5-year average of 0.33. What does this mean for you? When correlations increase, the differentiation between stocks is diminished: stock-specific news like earnings releases are overshadowed by general market sentiment.

Should you buy stocks after stock market sell-offs? While “Buy The Dip” has become the cry of day traders, we think it might make sense to be more selective.

Dispersion is a better measure of differentiation in stocks as it measures the average deviation of share-price changes. A low dispersion calculation implies very low differentiation; conversely, high dispersion suggests very great differentiation. If average correlation is high while dispersion is high, it may make sense to “Buy the dip”. However, if correlations are high and dispersion is low, it may make more sense for investors to consider more macro vehicles like ETFs to better manage sharp moves in US equities.