Monday, July 10, 2017

Dow And S&P 500 Haven’t Been This Disconnected Since 2003

S&P 500 and the Dow set to gain about 8% so far in 2017, while the Nasdaq is on track for a year-to-date climb of 13.4%.


By Mark DeCambre
MarketWatch
July 10, 2017

A pair of typically closely correlated equity benchmarks haven’t been seeing eye to eye, lately.

The Dow Jones Industrial Average DJIA, +0.44% and the S&P 500 index SPX, +0.64% the most popular stock-market gauges, usually move in lockstep, displaying what is known as a positive correlation. But in recent trade, the equity indicators have seen the lowest level of correlation since 2003, according to data from WSJ Market Data Group, tracking a 20-day rolling average of the benchmarks over the past 15 years (see chart below):



A reading of 0.00 describes no relationship between two assets, while 1.00 means assets are perfectly aligned, moving in the same direction at the same time.

A 15-year average of the Dow and the S&P 500 shows that the relationship is nearly perfect at 0.9557. However, the rolling 20-day period shows a stark erosion of that relationship, with a reading of 0.4655. marking the lowest level of correlation between the S&P and the Dow industrials since Aug. 4, 2003.

What’s behind the recent mini trend?

Some market participants point to the recent downturn in the tech sector, which began in earnest around June 8 after many of the biggest names in the sector touched recent highs, including Amazon.com Inc. AMZN, +1.41% Nvidia Corp. NVDA, +2.29% and Netflix Inc. NFLX, +2.69% only to stage a sharp retreat.

The tech slide, which represents some of the largest publicly traded companies by market value, has weighed on the broader stock market, hitting the tech-laden Nasdaq Composite Index COMP, +1.04% more severely than its peer equity gauges.

But the S&P 500 also has been influenced by the recent tech slump because that sector represents 22% of the S&P 500’s weighting. So, moves in tech tend to outweigh shifts in other sectors including health-care and financials.

Technology shares in the Dow account for 20% of the Dow but because the blue-chip gauge is price-weighted—meaning companies with higher prices hold outsize influence over its direction—trading in Intel Corp. INTC, +0.74% Visa Inc. V, +0.72% (considered a technology name in the Dow), Cisco Systems Inc. CSCO, +0.59% Apple Inc. AAPL, +1.02% Microsoft Corp. MSFT, +1.30% and International Business Machines Corp. IBM, +0.38% don’t hold as much sway as, say, Goldman Sachs Group Inc. GS, -0.62% Boeing Co. BA, +0.44% or 3M Co. MMM, +0.75% which all boast share prices of at least $200.

Investors also have been shifting from tech into banks, like Goldman, as the Federal Reserve looks set to continue to lift interest rates and normalize monetary policy, which should underpin gains for the banking sector. The collapse in the tech sector also has reflected investors’ concerns about valuations following a record run that had pushed prices to records, making the group vulnerable to a sudden downturn.

Against that backdrop, the broad-market S&P 500, with a little over 500 components, has lost its connection with the Dow, which tracks 30 companies.

Over the 20-day period since June 8, the Nasdaq Composite has declined 3.4%, while the S&P 500 is off just 0.8% and the Dow boasts a gain of 0.9%, according to FactSet data.

But that disconnect isn’t likely to be a permanent one. Indeed, over the past year, returns for the S&P 500 are more in sync, with the S&P 500 and the Dow set to gain about 8% so far in 2017, while the Nasdaq, despite its recent slump, is on track for a year-to-date climb of 13.4%.

“The disconnect is probably due to the tech stocks because some of the biggest companies are tech stocks but not many of them are in the Dow Jones,” said Randy Frederick, managing director of trading and derivatives at Schwab Center for Financial Research.


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