S&P 500, Dow Jones and Nasdaq – The Deceptive Intricacies of Popular Stock Market Indexes

On first glance the performance of the Dow Diamonds (DIA), S&P 500 SPDR (SPY) and Nasdaq QQQ (QQQ) seems to be closely correlated. This first glance assessment, however, couldn’t be farther from the truth. Here’s what separates the indexes from each other and why it’s important.

Index investing or ETF index investing is a popular and low-cost way to put your dollars to work, it’s like putting your portfolio on cruise control.

But driving on cruise control isn’t always the best way to get from A to B and doesn’t mean you won’t get into an accident. It merely means that you delegate speed control to your car.

Your level of commitment to your own portfolio ultimately dictates your style of investing: buy and hold via indexes or ETFs, buy and hold via actively managed mutual funds, or a more active approach to buying and selling.

Regardless of what type of investor you are, you need to be familiar with your investment vehicle(s) of choice, just like a driver needs to know the difference between automatic and stick shift.

Look Under the Hood

The S&P 500, Dow Jones, and Nasdaq are the most popular U.S. indexes and if you are an investor, odds are some of your money is invested in one or more of those three indexes.

Equity indexes are often described as a basket of stocks. Retirees or near retirees are familiar with the term nest egg and the comforting picture of many golden eggs nested up to provide a comfortable retirement.

But what if the basket of eggs is made up of one or two giant ostrich eggs that limit the space for other eggs? That wouldn’t be well diversified and one knock against the basket could scramble most of the retirement.

Hidden Ostrich Eggs

Financial ostrich eggs among major U.S. indexes are more common than you think.

IBM accounts for nearly 12% of the Dow Jones Industrial Average (DJIA or Dow Jones). Technically speaking, the DJIA is an average not an index. The DJIA is price weighted, in other words only the price of a stock matters, nothing else.

IBM is the most expensive stock of the DJIA and moves the index (or average) 20x more than Bank of America (BAC) even though IBM has only about twice the market capitalization (the price per share multiplied by the amount of outstanding shares) of BAC.

The ETF that best represents the DJIA is the SPDR Dow Jones Industrial Average ETF. Its ticker is DIA, that’s why it has the nickname Dow Diamonds ETF.

The Nasdaq-100 and the PowerShares Nasdaq QQQ ETF (QQQ) hide another “ostrich egg,” – Apple. Apple accounts for a whopping 20% of the Nasdaq-100 Index. If you already own Apple or don’t believe Apple is the way to play technology, you may not want to own QQQ.

The S&P 500 Index – represented by the S&P 500 SPDR (SPY) – provides more balanced diversification than the DJIA or Nasdaq-100. Apple, still the biggest player of the S&P 500, accounts for less than 5%. IBM has a weight of only 1.8%.

Considering the different composition of the three indexes, it’s remarkable how closely their day-to-day moves correlate.

The chart below provides a visual of the long-term correlation between the Dow Diamonds (DIA), S&P SPDR (SPY), and QQQs. Illustrated is the percentage change since April 1999 (when the QQQs began trading) to provide an apples to apples comparison of the three indexes.

The SPY and QQQ delivered a near identical return (+38%). The DIA is up 68% since April 1999. Of course the picture looks much different if you start measuring the return from the 2000 highs.

All three indexes and index ETFs share the commonality of having had very sizeable swings ranging from -60% to +60%. The Profit Radar Report advocates an investment approach that capitalizes on larger up moves and turns neutral or short during major down moves.

This approach can significantly enhance your return and reduce your exposure to risk.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

Advertisements

S&P 500 vs. Investors – Are Retail Investors Really the “Dumb Money?”

Retail investors have many choices to buy and sell stocks: Mutual funds and ETFs are just two of them. Regardless of the options, investors are often considered the “dumb money.” Is the dumb money really dumb?

Wall Street geniuses and the financial media often consider retail investors the “dumb money.” That’s ironic, because Wall Street and the media are notorious for dishing out group think advice that’s getting many of the small guys burned.

There’s plenty of data that shows that a plain index investing or index ETF investing approach (the real “dumb” buy and hold a basket of stocks approach) handily beats the returns achieved by Ivy League educated mutual fund managers that engage in actively buying and selling.

If you’ve read my articles before you know that I like to pick on Wall Street and the financial media, but today we’ll talk about the investing prowess of retail investors – the “dumb money.” Is the dumb money really dumb?

Is the Dumb Money Really Dumb?

One of the best measures of retail investor’s appetite for stock is the asset allocation poll conducted by the American Association for Individual Investors (AAII).

The chart below plots the S&P 500 Index (SPY) against investors’ portfolio allocation to stocks. Investors’ stock allocation pretty much waxes and wanes with the performance of the S&P and almost plots a mirror image of the S&P.

Unfortunately, the cliché is true; retail investors buy when stocks are high and sell when stocks are low. I believe this is due to crowd behavior and the forces of investing peer pressure rather than stupidity, as the term dumb money implies.

What else can we learn from this chart aside from the fact that retail investors tend to buy high and sell low?

The average allocation to stocks since the inception of the survey in 1987 is 60.9% (dashed red line). The S&P currently trades near a 52-month high, yet investors’ allocation to stocks is below average (60.5% as of August). This is unusual.

In fact, in the 21st century there’ve only been a couple of instances where investors’ stock allocation was below average when the S&P was near a 3+ year high. Those instances are marked with a red arrow. In August 2006 stocks went on to rally. In March 2012 stocks declined first and rallied later.

Lessons Learned

The lesson for investors is A) not to follow the crowd and B) not to follow Wall Street or the financial media.

The mission of the Profit Radar Report is to keep investors on the right side of the trade. A composition of indicators used identified the March 2009 and October 2011 lows as investable lows and got investors out of stocks at the 2010, 2011, and 2012 highs.

Simon Maierhofer shares his market analysis and points out high probability, low risk buy/sell recommendations via the Profit Radar Report. Click here for a free trial to Simon’s Profit Radar Report.

Apple Bullies the Nasdaq and S&P 500 But May Soon Disappoint Investors

The S&P 500, Nasdaq-100 and Technology Select Sector SPDR ETF are rallying to new multi-year recovery highs spurred by Apple’s record setting performance. As Apple goes, so goes the market, so what’s next for Apple?

Monday, August 20, 2012 is the day when Apple became the most valuable publicly traded company ever. That day the stock closed at $665.15 a share, giving it a market capitalization of $623.52 billion.

The previous record was set by Microsoft in 1999 when it was valued at $616.34 billion.

Apple is most certainly the biggest fish in the pond. How big? Apple accounts for 4.73% of the S&P 500 Index tracked by the SPDR S&P 500 ETF (SPY). The closest second is Exxon Mobil with a weighting of 3.22%.

All by itself, Apple’s share price matters almost as much as that of IBM, Microsoft and General Electric combined. While Apple dominates the S&P 500, it outright bullies the Nasdaq-100.

At $665 a share Apple controls 19.65% of the Nasdaq-100 and the ETF that tracks this index, the PowerShares QQQ (QQQ). Even more lopsided is AAPL’s share in the Technology Sector SPDR ETF (XLK), where it accounts for 20%.

Apple is so big that when Apple sneezes the U.S. stock market gets a cold. So how is Apple’s health?

Fundamental Analysis – New iPhone, New iPad … New Highs?

Consumers and investors are highly anticipating the new iPhone 5, the new iPad mini and Apple TV. With the holiday season coming up there are plenty of reasons to expect new all-time highs and record valuations for AAPL.

Apple trades at only 13 times earnings and many analysts consider Apple stock cheap.

Technical Analysis – Strong Resistance in Sight

The chart below shows AAPL on a log scale since 2000. I have shown the chart before, most recently in the July 22 Profit Radar Report, which stated that: “The upper red resistance channel will be around 660 later this week. A final push to kiss this trend line good bye would provide a beautiful technical picture and a solid sell signal.”

On Tuesday, August 21, the upper trend line resistance is at 679. Shares weren’t quite able to touch the line, which allows for new highs in the coming days.

If Apple shares follow the path of seasonal patterns in election years, we should see a top in Apple in late August followed by another seasonal high in November/December.

 

For a Risk Free Trial of ispyetf.com Click Here to sign-up today!

Will Small Cap Stocks Catch Up and Trigger a Buy Signal for the S&P 500?

“The stock market is doomed because small cap stocks are trailing behind the S&P” has been the financial media’s message. Obviously the market is doomed eventually, but for now this piece of Wall Street “wisdom” hasn’t paid off. Here’s what the Russell 2000 is telling us.

Small Cap stocks represented by the Russell 2000 and ETFs like the iShares Russell 2000 Index ETF (IWM) have received their fair share of media attention lately.

The focus has been on the under performance of the Russell 2000. This has been considered bearish for the S&P 500 (SPY), Dow Jones (DIA), and Nasdaq (QQQ) since small cap stocks are often viewed as a barometer for the market as a whole.

The Profit Radar Report has been promoting an individual and independant analysis of small caps, financials (XLF) and the Nasdaq to get a better read on the big picture.

Myth Buster

One detailed piece of analysis has shown that under performance by the Russell 2000 is not necessarily negative for the stock market.

There have been nine occasions over the last 20 years where the S&P was within 1% of a multi-month high (1,392 on July 30) while the Russell 2000 was more than 5% below a multi-month high (820 on July 5). This led to small negative returns only three times.

Above Resistance

Even though the whole lagging Russell doom scenario is busted, the Russell broke above key resistance. This happened on August 7, with a close above 800 (a day before XLF broke above resistance at 14.85).

Although the Russell was still lagging the S&P, this break was important and signaled more gains for small caps (financials) and the overall market.

The chart below plots the S&P 500 (SPY) against the Russell 2000 (IWM) and reveals divergences at various degrees.

In May 2011 the Russell 2000 Index recorded an all-time high. The S&P did not. Since then the S&P has nearly reclaimed its 2012 high while the Russell 2000 is about 5% away.

The S&P 500 is about 10% away from its 2007 all-time high, while the Russell 2000 is only 6% away from its 2011 all-time high.

If you are looking for a divergence between the S&P 500 and Russell 2000, you’ll find more than just one, some bullish, some bearish.

The chart below shows immediate resistance for the Russell 2000 and S&P 500 Index (red lines) and short-term support. There are indicators that suggest an upcoming sell off, but as long as prices remain above short-term support (green lines) the trend is up.

 

Financials – Is the Most Despised U.S. Sector Getting Ready to Rally?

Investors are shunning the financial sector. Although financials account for more than 14% of the S&P 500 (SPY), investors (by one measure) have only 2% of their money invested in financials. Some contrarians take this as a buy signal, is it?

Knight Capital, MF Global, LIBOR fixing scandal, JP Morgan losses, excessive Wall Street bonuses … there seem to be unlimited reasons to dislike the financial sector (Financial Select Sector SPDR ETF – XLF).

When it comes to financials, investors are not only talking the talk, they are walking the walk. Right now financials are the most despised sector in the United States. Of the $900 million invested in Rydex sector funds, only $18 million are allocated to financials, that’s just 2%.

However, the financial sector accounts for 14.21% of the S&P 500 Index (SPY), which makes it the second biggest sector of the S&P (behind technology).

Extreme pessimism often results in unexpected price spikes. Is the financial sector getting ready to rally?

The Technical Take on Financials

Financials appear to be at an important short-term juncture, but let’s provide some long-term context before looking at the short-term.

From the 2009 low to the 2011 high, the financial sector (XLF) jumped from $5.88 to $17.20. Before that, XLF dropped from 38.15 to 5.88. Today XLF trades 61% below its all time high price tag of 38.15. In comparison, the Dow Jones Industrial Average (DJIA) is less than 8% away from its all-time high.

Important short-term resistance for XLF last week was at 14.85. This resistance was made up of the July 3 and 27 highs and a trend line that connects the March 27 and May 1 highs.

On August 8, XLF was able to close above 14.85. Such a break out is generally bullish. However, the volume on which XLF broke out was significantly lower than average (see chart below).

Based purely on the chart and sentiment, the bullish message deserves the benefit of the doubt as long as XLF remains above 14.80. But a break below 14.80 would severely ding the immediate up side potential for XLF.

What about the down side risk? Aggressive investors may decide to sell or go short XLF with a break below 14.80. The initial down side target would be around 14.45 – 14.50.

Using Asset Class Correlations to Predict Stock Market Moves

Every day about a billion shares of stocks exchange hands on the New York Stock Exchange , but stocks are not the only asset class on the planet. Currencies and bonds are part of the same financial eco system, and we shouldn’t ignore their effect on stocks.

There’s a Bavarian saying that encourages people to “look beyond the edge of their own plate.” Translated in investment terms this means to expand your horizon and look at more than just one asset class.

Several times over the last couple of months the S&P 500  (SPY) has been declared “dead”. In fact, a recent CNBC headline said that: “Bill Gross is latest to join ‘stocks are dead’ club.”

The Fed could have jolted the S&P back to life with a dose of QE3, but decided not to. Against all odds, rather than rolling over, stocks have sprung back to life – a case of “dead man walking.”

On July 25, with the S&P trading as low as 1,331, a special Profit Radar Report outlined why stocks are not ready to decline just yet.

The key to this bold forecast was found in the correlation between various asset classes. Below are excerpts from the special July 25 Profit Radar Report.

July 25, Special Report: Asset Class Correlations

Some asset classes boom while others bust and vice versa. For example, bond prices typically rise when stock prices fall. Those types of asset class correlations should be taken into consideration for any market forecast.

Individual outlook for long-term Treasuries: Long-term T’s are butting up against long-term resistance while relative strength (RSI) is lacking price. This suggests that long-term Treasuries are in the process of topping out. Falling Treasury prices typically means rising stock prices.

Individual outlook for the euro: The euro has been trending down since March 2008 and is currently trading just above the June 2010 low. Although euro prices dropped below the June 1, 2012 low, RSI is solidly above the June 1 low. This suggests that the euro is trying to find a bottom that lasts for more than just a few days. Any bounce could gather steam if the euro is able to move above resistance. A strengthening euro is usually good for stocks.

What this means for stocks: If the euro rallies and long-term Treasuries decline, stocks should move higher or at least have a hard time declining.

The chart below shows how the iShares Barclays 20+ Treasury Bond ETF  (TLT) and Currency Euro Trust (FXE) perform during times when the S&P is in an extended up or down trend.

With Treasuries near a top and the euro near a bottom, stocks should rally or at the very least have a hard time declining.