Thomson Reuters
- The S&P 500's sector correlations suggest the current rally can go to year-end, DataTrek Research said.
- The indicator is a sign of investor confidence, and it's hovering near levels seen around bull markets of the past.
- "The S&P 500 does not tend to see a near term top until correlations are well below average, and we are far from those levels right now."
The stock market is in the midst of a strong November rally, and according to DataTrek Research, the gains could last through year-end thanks to a key historical trend.
In a Tuesday note, the firm's co-founders Nicholas Colas and Jessica Rabe point to US large-cap sector correlations as reason for bullishness and investor confidence.
"When [investors] see clear skies ahead, correlations tend to be low as they pick and choose between individual sectors and stocks," Colas and Rabe said. "When investors are concerned that a recession is brewing, whatever the cause, correlations are high because they see too much risk in owning equities as an asset class. Everything gets sold in such an environment."
The correlation in question is just over the long-run average of 0.83, as highlighted in the chart below. When correlations hover above that level, stocks tend to be under pressure; when they are below, stocks tend to rally like they did in 2020-2021, and between January and July of this year.
"The S&P 500 does not tend to see a near term top until correlations are well below average, and we are far from those levels right now," the strategists said.
DataTrek Research
Earlier in July, correlations touched unusually low levels at 0.60 as the S&P 500 notched year-to-date highs.
It is also not unusual for correlations to temporarily go slightly above average during bull markets, which happened three times during the 2020-2021 bull market and three times in 2019, Colas and Rabe noted.
Despite the S&P 500's more than 10% surge from October 27 lows, correlations have stayed elevated because it was a broad "everything rally."
"The bottom line here is that we believe US equities will continue to rally in the coming weeks," the strategists said.