Sector Correlations and Defensives

If you’ve owned ‘the market’, forget diversification — you’ve owned a tightly linked cyclical machine.

Over the past year, the S&P 500 has moved almost in lockstep with the Technology sector, with a very strong positive correlation of 0.94. It is followed closely by Industrials, Consumer Discretionary, and Communication Services — all four classified as cyclical sectors by MSCI. And it doesn’t stop there — these cyclical sectors are strongly correlated with one another, around 0.8. Using thefinancial.ai, we can easily generate the following correlation matrix for the S&P 500 sectors:

What’s more, Technology carries the highest beta among the eleven sectors, amplifying volatility.  If you’re looking to dampen macro-driven swings, it may be worth rotating toward defensive sectors, especially Consumer Staples. Notably, the lowest value in the correlation matrix is between Consumer Staples and Technology, with similarly low correlations to Consumer Discretionary and Communication Services. Better yet, Consumer Staples also has the lowest correlation and beta with the S&P 500. 

The year-over-year overlays make the contrast clear at a glance: Technology accelerates with the S&P 500 and amplifies every move, while Consumer Staples charts a distinct path — breaking the market's lockstep to provide the defensive ballast that a cyclical-heavy portfolio lacks.