A look under the surface of the S & P 500 may signal the benchmark is due for a pullback. DataTrek Research co-founder Nicholas Colas noted that S & P 500 sector correlations are nearly 2 standard deviations below their long-term average at 0.64. This, Colas said, indicates “excessive animal spirts” are driving the market. In this case, investors appear to be chasing the tech sector and AI plays, while neglecting the rest of the market. Colas said that instances of such low correlation do not bode well for investors. “Correlations have been at similar levels 3 times since the start of the current bull market in 2023, and each time the index pulled back by 5 – 18 percent,” he said in a note to clients. The first instance of such low correlation came about on July 31, 2023. Between then and Oct. 2, 2023, the S & P 500 lost 10.3%. The second took place June 24, 2024, then the index lost 4.8% through Aug. 7 of that year. The last time this happened was earlier this year, on Feb. 6. What ensued was an 18.1% plunge through April 8, Colas pointed out. To be sure, three instances is a small sample. On top of that, global markets face major one-time events during each of these low-correlation occurrences (think the unwind of the yen carry trade in 2024 , the sell-off that ensued following “liberation day” earlier this year and a big swing higher in Treasury yields in 2023). But, as Colas points out: “S & P sector correlation data clearly shows investor optimism is getting to uncomfortably high levels, which means we need to keep an eye out for potential negative macro surprises. … That, combined with October’s reputation for outsized volatility, will leave stocks open to a choppier stretch before the customary year end melt up.” October ranks seventh in terms of the best months of the year for stocks, according to the Stock Trader’s Almanac. The benchmark averages a gain of just 0.9%. However, the biggest sell-off in Wall Street history took place that month, with the Black Monday crash occurring on Oct. 19, 1987. The S & P 500 climbed 0.4% on Monday, hitting a fresh all-time high.
‘Animal spirits’ measure signals a market pullback could be near
