The Dow And S&P Are Dancing Cheek To Cheek

In recent years the Dow has gotten ridiculed as a stodgy old index that isn't representative of the overall stock market.  It's important to remember, however, that the Dow's correlation on a day-to-day basis with the broader S&P 500 remains extremely high.  Below is a chart showing the rolling one-year correlation between the Dow and the S&P 500 using daily percentage moves over the last 30 years.  As shown, the correlation between the two indexes over the last year is just under 0.97 (1.0 is perfectly correlated), which is a very high reading.

You'll notice in the chart that the correlation between the Dow and the S&P 500 has been trending slightly lower since the start of the bull market. This slow creep lower is normal during long-term uptrends.  It's interesting to note that the correlation between the Dow and the S&P 500 peaked recently right at the lows of the bear market in 2009.  One of the tenets of investing is diversification, but as investors saw first hand during the financial crisis, correlations tend to spike towards 1 during big downturns, which pretty much defeats the purpose of asset allocation!

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