Why Worry About 500 Stocks When You Only Need to Follow Three?

Paul Hickey of www.bespokeinvest.com looked at 6-month correlations between the 500 components of the S&P 500 and the benchmark as a whole. He found only three that match the index almost move for move.

Correlation (also called R-squared) ranges between -100 and +100, where +100 indicates perfect correlation and -100 perfect negative correlation. Zero implies no correlation at all. Statisticians generally consider absolute readings above 75 "statistically significant." So, finding three stocks that correlate to the index 95 percent of the time is a big deal. Just look at how Paccar Inc. tracks the S&P 500:

Given the tightness of these relationships, what's happening at these three companies should provide some insight into what's driving the broader market, and maybe even provide a glimpse into the future. So we scanned the news releases and analyst notes of the past several weeks. Here's what we found:

There are three striking macro themes: consumer resilience; margin expansion; dividend/buybacks. We've discussed these themes on-air with television guests for months. No wonder these three stocks correlate so closely with the S&P 500: they're a perfect microcosm for the market.

As to their predictive value for investors, it's worth noting the earnings estimates from analysts tracked by Bloomberg: all forecast growth during the next two quarters and into next year. Again, we cite 95 percent correlation: if these companies are growing, the S&P is growing, perhaps even faster than the current forecast of 6 percent, given double digit growth at our big three.

For the benefit of blog readers, here are seven additional companies that very nearly made the list, tracking the S&P 500 94 percent of the time: Automatic Data Processing Inc (ADP), Bank of New York Mellon Corp. (BK), Dun & Bradstreet Corp. (DNB), Honeywell International (HON), Lam Research Corp. (LRCX), Marsh & McLennan Cos. (MMC) and Paychex Inc. (PAYX).

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