Correlation Analysis

With a quick glance at the chart to the right, one could conclude, as I have stated many times, the 2 for 1 Index seems highly correlated with the overall market, meaning both indexes go up and down more or less in lockstep. Because the 2 for 1 Index has been underperforming so far in 2024, I got curious as to how closely 2 for 1 actually has matched the ups and downs of the market over the years and whether or not it makes a difference. It turns out it hasn’t been that close at all.

Comparing the monthly closing number for both indexes, I found 2 for 1 matching the direction of the market only 55% of the time. For the other months, the market was up and 2 for 1 was down 24% of the time, and 2 for 1 was up while the market was down 21% of the time. These numbers involve only the direction to the moves, not the magnitude. Obviously, over time, 2 for 1’s moves to the upside have been more pronounced, hence the overall outprformance of the 2 for 1 Index vs the S&P500 Total Return Index over 28 years.

Mathematicians tell me that a 30 stock portfolio (actually anything over 25), diversified over market cap and sector, will eliminate all risk except basic market risk. In other words, a number less than 25 would mean you would begin to have the risk of one or two very poor performers causing severe damage, where that damage could be tolerated if it involved a smaller percentage of the portfolio. Conversely, any number over 30 would provide no extra risk protection – your risk would be the same as that of the overall market.

So we are left with the idea that 30 well diversified stocks do provide the same risk protection as a broad market index but will not necessarily form a portfolio that moves in lockstep with the market. For 2 for 1, I’ll take comfort in the fact that the Index is made up of companies that, over the long term, and on average, will outperfom the market due to the Stock Split Advantage.