This week has been a choppy one on Wall Street. In an uncertain market, a well diversified portfolio across different geographies, sectors and asset classes is what the doctor ordered. However, intuition and guesses are not always the best way of finding diversification opportunities. A more analytical way would be to look at correlation coefficients between the potential investment sectors and the S&P 500.
Let’s get some basics out of the way before the analysis. Correlation coefficients range from -1 to 1. A correlation coefficient of 1 implies that a sector increases in price every time the market increases in price and vice versa. With that knowledge, here are some numbers: Technology has a 0.89 correlation to the S&P; Consumer Discretionary has a 0.69 to the S&P; 0.46 for Finance; 0.28 for Healthcare; 0.06 for Real Estate and 0.02 for Consumer Staples.
The popular saying is that “There Are No Bad Sectors, Only Bad Correlations”. And so, with the markets after hitting all time highs and pulling back this week, what are investors to do with their portfolios?
Future Wealth’s View
Diversification is at the heart of sound investing. Since no two sectors move perfectly in tandem, an investor can only mitigate risk by gaining exposure to a variety of sectors and asset classes. With the current high valuations and extremely low volatility, investors have little margin for error and as such requires investors to think judiciously about not just sector selection but also about how portfolio components interact with one another.
At Future Wealth, our approach has always been geared toward capital preservation while providing channels for growth and income. Even as our clients have enjoyed strong growth this year through higher than normal exposure to the S&P 500, we have traditionally diversified our clients on several sectors that are not so strongly correlated to the S&P 500 to provide downside protection.
While the Da Vinci “Salvator Mundi” painting that sold for $450 million earlier this week could be debatable, no one is going to dispute the power of investing in low correlation investments.