GE Divergence Not All It's Cracked Up to Be
Yeah, well, you know what they say about statistics!
Someone posed a question to me yesterday that they first heard about from the trading floor blog on Bernie Schaeffer's site. Namely, it involved the stark divergence between the S&P 500 and General Electric.
Over the past 40+ years, the correlation between GE and the S&P is about +.98 (on a scale of -1 to +1), which is nearly perfect. But that's a pretty misleading stat, since they both have been in such long, steady uptrends. A more accurate way to look at the correlation between the two is look at their quarterly changes...if GE was negative over the past three months, was the S&P too?
For the most part, yes. The correlation then drops to +.70, which is still high enough to suggest that it is unusual to see the two diverge so widely (which should be obvious since GE is so huge and is a part of the S&P index).
Over the past quarter, the correlation between GE and its mother index has been -0.30, one of the larger divergences we've seen in 40 years. What's even more unusual is that GE is down nearly 5% in this time, meaning that the S&P 500 has held up quite well despite the poor performance of one of its leaders.
There have been 6 distinct times since 1962 when we've seen the rolling 3-month correlation between GE and the S&P 500 fall below -.25 while GE has declined more than 4% during that time, which encompasses 104 total days. Again, what this means is that the S&P has held up by diverging with the weakness shown by GE.
To see if that led to anything consistent going forward, we looked at the average return in the S&P over the next quarter, and found that it averaged +4.7%. What seems remarkable, though, is that out of the 104 days that qualified for the study, the S&P was positive after 102 of them.
Many have been fretting about this divergence, assuming that GE will be dragging the S&P down. But looking at history, we see that typically the exact opposite thing happened, with the S&P doing quite well over the next quarter.
Below is the rolling 3-month correlation between the two. It shows just how unusual the current occurrence is.
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