US Stock Market Sectors

Interpretation

The chart above gives a different view of the same data from the ratios above. Presented below are brief sector descriptions along with some example companies.

• Energy Sector: This sector includes companies involved in the exploration, production, refining, and distribution of oil, gas, and other energy sources. Example companies: Exxon Mobil, Chevron, ConocoPhillips.
• Materials Sector: This sector encompasses companies involved in extracting and processing raw materials. This includes metals, chemicals, and construction materials that are foundational to manufacturing and construction industries. Example companies: Linde PLC, Sherwin-Williams, Freeport-McMoRan.
• Industrials Sector: This sector comprises companies involved in manufacturing, construction, transportation, and industrial services. Example companies: Caterpillar, Union Pacific, Boeing, General Electric.
• Utilities Sector: Companies in this sector provide essential services like electricity, gas, and water supply. Example companies: NextEra Energy, Southern, Duke Energy.
• Healthcare Sector: This sector includes companies involved in healthcare-related activities, such as pharmaceuticals, medical equipment, and healthcare services. Example companies: UnitedHealth Group, Eli Lilly, Johnson & Johnson, Merck.
• Financials Sector: Companies in this sector provide financial services, including banking, insurance, and asset management. Example companies: Berkshire Hathaway, JPMorgan Chase, Visa, Mastercard, Bank of America, Wells Fargo.
• Consumer Discretionary Sector: This sector produces goods and services considered non-essential but desirable if consumers have the disposable income. It covers retail, automobiles, and leisure, often seen as a reflection of consumer confidence and economic health. Example companies: Amazon, Tesla, Home Depot, McDonald's, Nike.
• Consumer Staples Sector: Companies in this sector produce and distribute essential consumer products like food, beverages, and household items. Example companies: Procter & Gamble, Costco, PepsiCo, Coca-Cola, Walmart.
• Information Technology Sector: This sector comprises companies involved in technology development, software, hardware, and IT services. Example companies: Microsoft, Apple, Broadcom, Nvidia, Adobe.
• Communication Services Sector: This sector includes companies involved in communication and media services, including telecommunications and entertainment. Example companies: Meta, Alphabet, Netflix, T-Mobile, Electronic Arts.
• Real Estate Sector: This sector includes companies involved in real estate development, management, and investment. Example companies: Prologis, American Tower, Equinix, Crown Castle.

Interpretation

The chart above shows a heat map depicting the correlation coefficients among various US stock market sectors. Each sector is represented on both the x and y axes, with intersections revealing the strength and direction of their correlation. A correlation coefficient of +1 indicates a perfect positive correlation, implying that two sectors moved in the same direction during the specified time window. Conversely, a coefficient of -1 signifies that the sectors moved in opposite directions. Colors range from deep blue, indicating a negative correlation, to dark red, signifying a strong positive correlation. The chart shows that over a long time frame the Energy sector exhibits the weakest correlation with the other sectors.
The correlation coefficient is important to consider for diversification because it helps investors assess the potential benefits of including different assets in their investment portfolios. Diversification is the practice of spreading investments across different assets to reduce risk. In his book Principles, Ray Dalio called diversification the “Holy Grail of Investing”. He realized that with fifteen to twenty uncorrelated return streams, he could dramatically reduce the risks without reducing the expected returns.

Interpretation

The minimum spanning tree (MST) simplifies the data from the correlation matrix above by retaining only the strongest correlations between the sectors. If two sectors are connected, it means that they are positively correlated and that they tend to move in tandem. By analyzing the structure of the MST, one can identify clusters of assets that move together. This visual tool is especially beneficial when considering portfolio diversification. In fact, Marti, Gautier, et al. (2017) found that the optimal Markowitz portfolio is found at the outskirts of the tree and that the tree shrinks during a stock crisis.

Data Sources

• Yahoo: SPDR S&P 500 ETF Trust (SPY)
• US Stock Market Sectors:
• Yahoo: Energy Select Sector SPDR Fund (XLE)
• Yahoo: Materials Select Sector SPDR Fund (XLB)
• Yahoo: Industrial Select Sector SPDR Fund (XLI)
• Yahoo: Utilities Select Sector SPDR Fund (XLU)
• Yahoo: Health Care Select Sector SPDR Fund (XLV)
• Yahoo: Financial Select Sector SPDR Fund (XLF)
• Yahoo: Consumer Discretionary Select Sector SPDR Fund (XLY)
• Yahoo: Consumer Staples Select Sector SPDR Fund (XLP)
• Yahoo: Technology Select Sector SPDR Fund (XLK)
• Yahoo: Communication Services Select Sector SPDR Fund (XLC)
• Yahoo: The Real Estate Select Sector SPDR Fund (XLRE)