ORRELATION IS THE MOST CRITICAL element in the creation of efficient portfolios. The lower the correlation between assets, the greater their risk-reducing effect when combined together. On the other hand, assets that are highly correlated add little benefit when held in the same portfolio. Correlations range from +1 to -1 with the former being perfect positive correlation and the latter perfect negative correlation. A correlation of 0 indicates no correlation. Assets are always perfectly correlated (+1) with themselves. Table 1 shows the correlations of each of the eleven sectors in the S&P 500. Data is derived from the period January 1993 - December 1998.
| TABLE 1 S&P 500 Sector Correlation | |||||||||||
| Sector | Basic Materials |
Cap Goods |
Comm. Services |
Cons. Cyclicals |
Cons. Staples |
Energy | Financials | Health Care |
Tech | Transp. | Utilities |
|---|---|---|---|---|---|---|---|---|---|---|---|
| Basic Materials |
1.000000 | 0.745886 | 0.227073 | 0.529040 | 0.431215 | 0.589843 | 0.543409 | 0.322050 | 0.387788 | 0.689876 | 0.186541 |
| Cap Goods |
0.745886 | 1.000000 | 0.457956 | 0.734237 | 0.720396 | 0.542911 | 0.706673 | 0.554503 | 0.710582 | 0.746161 | 0.213460 |
| Comm. Services |
0.227073 | 0.457956 | 1.000000 | 0.460325 | 0.525370 | 0.192761 | 0.551826 | 0.406097 | 0.373566 | 0.500534 | 0.499180 |
| Cons. Cyclicals |
0.529040 | 0.734237 | 0.460325 | 1.000000 | 0.723947 | 0.353249 | 0.708323 | 0.459776 | 0.514543 | 0.702975 | 0.147365 |
| Cons. Staples |
0.431215 | 0.720396 | 0.525370 | 0.723947 | 1.000000 | 0.325758 | 0.722048 | 0.698235 | 0.511733 | 0.624331 | 0.330469 |
| Energy |
0.589843 | 0.542911 | 0.192761 | 0.353249 | 0.325758 | 1.000000 | 0.488204 | 0.254009 | 0.345953 | 0.550128 | 0.473824 |
| Financials |
0.543409 | 0.706673 | 0.551826 | 0.708323 | 0.722048 | 0.488204 | 1.000000 | 0.575677 | 0.496605 | 0.761269 | 0.344033 |
| Health Care |
0.322050 | 0.554503 | 0.406097 | 0.459776 | 0.698235 | 0.254009 | 0.575677 | 1.000000 | 0.503687 | 0.448687 | 0.231354 |
| Tech |
0.387788 | 0.710582 | 0.373566 | 0.514543 | 0.511733 | 0.345953 | 0.496605 | 0.503687 | 1.000000 | 0.456923 | 0.028758 |
| Transp. |
0.689876 | 0.746161 | 0.500534 | 0.702975 | 0.624331 | 0.550128 | 0.761269 | 0.448358 | 0.456923 | 1.000000 | 0.328284 |
| Utilities |
0.186541 | 0.213460 | 0.499180 | 0.147365 | 0.330469 | 0.473824 | 0.344033 | 0.231354 | 0.028758 | 0.328284 | 1.000000 |
ISK AND RETURN ARE THE OTHER critical elements in efficient portfolio construction. Standard deviation -- the average variance about the mean value -- is a basic measure of risk. The greater the average deviation from the norm, the greater the risk. Table 2 shows this measure as well as the average and annualized returns for each sector of the S&P 500.
| TABLE 2 Risk and Periodic Returns - S&P 500 Sectors October 1, 1989 - September 30, 1999 | |||||
| Annualized | |||||
|---|---|---|---|---|---|
| Standard Deviation |
Arithmetic Mean |
1 Year | 3 Year | 5 Year | |
| Basic Materials | 11.02 | 12.27% | -6.11% | 5.78% | 9.89% |
| Cap Goods | 10.97 | 20.91% | 14.11% | 23.86% | 22.06% |
| Communication Services | 23.52 | 24.49% | 52.33% | 29.38% | 24.29% |
| Consumer Cyclicals | 16.94 | 19.77% | 36.31% | 29.32% | 19.57% |
| Consumer Staples | 14.36 | 20.60% | 22.22% | 25.18% | 24.12% |
| Energy | 12.44 | 16.97% | 0.54% | 16.54% | 16.54% |
| Financials | 23.01 | 25.96% | 11.43% | 30.54% | 27.00% |
| Health Care | 24.46 | 28.47% | 44.22% | 35.66% | 34.82% |
| Technology | 20.49 | 37.42% | 72.98% | 45.71% | 39.03% |
| Transportation | 20.35 | 14.04% | -1.94% | 13.26% | 11.17% |
| Utilities | 17.23 | 15.10% | 14.77% | 13.74% | 13.97% |
| S&P 500 Index | 9.82 | 22.85% | 19.33% | 25.31% | 23.44% |
