Correlations Are High

During bear markets, correlations between sectors in the S&P 500 Index tend to rise. When investors are pessimistic or emotion driven, less attention is paid to constituents within the index and traders tend to sell or buy the market as a whole with risk-off or risk-on traders. This tendency contrasts to bull markets, when correlations usually decline as investors deploy capital in a more pragmatic and less reactive manner.

This graph demonstrates this tendency well. In March 2020, for example, when selling pressure was high and we experienced a brief, event-driven bear market, sector correlations nearly hit a perfect 1. A peak in correlations also coincided with the 2022 bear market. These spikes in correlations contrast to strong bull markets. Correlations fell considerably during the strong bull market in 2023 and 2024.

Recent price action in the market over the past several months has resulted in strong correlations again, which are expected in periods of sell-offs. The resulting high sector correlations are not surprising given the bear market we entered when the S&P 500 fell over 20% from its peak earlier this year.

If the market attains fresh highs later this year, sector correlations will likely decline as investors differentiate between sectors and industries within the index. The recent fall in correlations from the April peak indicates that investors are beginning to approach the market in a more rational and less emotional manner, which would be a bullish sign if it continues.

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