Correlate the Correlation

I don't know about anybody else, but I am constantly asking myself quantitative questions about the market. I like to use all kinds of analysis when looking at a stock. I'll usually first start by finding a chart that looks like it could make a move. Then, I'll check the news to see if anything could move the stock either with or against me. I don't think you can lock yourself in a room and just rely on one specific thing, although that would make investing much easier. I also like to think about patterns or relationships. This is usually when I bring quantitative analysis into the picture.

In this particular study, I was curious how the correlation worked out between stocks that were both in the Dow and the S&P 500. Let me lay down some quick groundwork. I got tired of hearing about the Dow constantly hitting new highs, while the S&P 500 seemed to be taking a much more sluggish more north. The Dow consists of 30 stocks, while the S&P 500 contains ___ (I'll let you fill in the blank). It seems obvious that the bag of 30 stocks should probably move easier than the bag of ___ (hope you still remember).

I picked the stocks listed below at somewhat random. Because the Dow is price weighted, I wanted to pick some of the highest, lowest, and middle priced. Then when I was done, I thought I would also make sure I have a decent industry showing. (A more dimensional study.)



As you can see there has been pretty good correlation over the long term, but as the time span shortens, the correlation tends to move around. Honeywell (HON) seems to maintain a consistent correlation with the Dow while Intel (INTC) has been lagging and by looking at the shortest time frame, is down right backwards.

Here are the same stocks only with the S&P 500 (damn I gave it away) instead of the Dow.



We get practically the same results when the S&P 500 is used. What are the exact differences you ask? Ahh, let me show you.



The bold numbers, by the way, represent either the high or low figure for that column. There are some larger numbers, but I don't know if this is statistically significant. You can figure that out if you are so inclined.

Also, one last chart. This shows the correlation between the Dow and the S&P 500. Nice isn't it. Seems pretty darn consistent.



Take what you want from this. My commentary may be way off, but the numbers don't lie (like Shakira's hips). If you're trying to ride the coat tails of the market, maybe picking a highly correlated stock will bring you along for the ride.