Dow Jones and S&P 500 Skew Broad Markets Real Performance

Based on the Dow Jones and S&P 500 it looks like stocks still need to conquer their 2007 highs before being ‘resistance free,’ but that isn’t the case. The Dow and S&P paint a deceptive and less bullish picture than reality.

If you don’t open your eyes to the bigger picture, you open your portfolio to unnecessary losses.

CNBC’s countdown clock will tell you that the Dow is only X points away from its 2007 all-time high. That’s true, but it’s also deceptive.

The Dow Jones Industrial Average is a price-weighted average of only 30 large cap stocks. IBM alone accounts for over 11% of the Dow’s movements.

The S&P 500 is a market capitalization weighted index of 500 large cap stocks that emphasizes the performance of the largest of large caps.

Mega Cap, ‘Mini’ Performance

Fact is that the bluest of the large cap stocks are lagging compared to the rest of the market. IBM is 5% from its all-time high as is Exxon Mobil. Oh yes, there’s also Apple, key player of the S&P 500, trading 36% below its high watermark.

A simple chart illustrates the ‘weakness’ of mega cap stocks compared to their large cap cousins. Figure 1 provides a visual comparison of the S&P 500 SPDR (SPY) and an equal weight S&P 500 ETF (Guggenheim S&P 500 Equal Weight ETF – RSP).

SPY trades about 3% below its 2007 high, equal weighted RSP trades more than 7% above its 2007 high. Why?

The top five S&P 500 components (Apple, Exxon Mobil, GE, Chevron, IBM) account for 11% of the index. Four of the top five holdings are more than 5% from their all-time highs.

The top five equal weight S&P 500 components account for 1% of the equal weight index and allow ‘smaller larger’ caps to pick up the slack of mega caps.

‘Smaller is Bigger’

Smaller is better in this QE bull market (more below). Mega caps underperform large caps, and large caps under perform small and mid-cap stocks.

Figure 2 plots the S&P 500 SPDR (SPY) against the MidCap 400 SPDR ETF (MDY) and SmallCap 600 SPDR ETF (SLY). The message is the same. MDY and SLY are at new highs, SPY isn’t.

What’s the Big Deal?

Stocks are up, portfolios are up, Wall Street is happy and the media is ecstatic, so what difference does it make who or what performs best?

Market tops are liquidity events. When investors stop buying, stocks start falling. Small and mid-cap stocks dry up first as they are most sensitive to liquidity squeezes.

That’s why small and mid-cap stocks tend to underperform somewhat going into larger scale highs. Thanks to the Fed’s artificial liquidity environment that hasn’t been the case.

Based on the strong showing of small and mid cap stocks and the absence of bearish divergences, the Profit Radar Report was expecting new highs even when the S&P traded well below 1,400 in November of last year.

Historic money flow patterns suggests that the overall trend remains up as long as small and mid cap stocks keep up with large caps.

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What The Dow’s Big Red Reversal Candle Means

On Monday the Dow spiked within 120 points of a new all-time high before falling hard. In fact, Monday’s red candle engulfs all of the 21 previous candles. However, the bearish candle is in conflict with bullish short-term indicators.

The Dow Jones Industrial Average (DJIA) reversed trends with an exclamation mark on Monday. After spiking to a new recovery high, the DJIA (corresponding ETF: Dow Diamonds – DIA) fell to a 21-day low.

A chart simply and elegantly displays a ‘bad day’ like this with a big red candle. This one red candle engulfs the 21 previous candles (shaded gray box).

This red candle high is also called a reversal candle. Candles like it tend to mark trend reversals. In this case from up to down. This doesn’t mean the Dow can’t and won’t eventually move higher (short-term bullish developments discussed below), but it cautions of lower lows ahead.

Two other facts enhance the message of this red candle. The high occurred right against a parallel channel anchored by the June/November 2012 lows and September 2012 high.

Perhaps even more importantly, the Dow stalled and reversed just before its all-time high water mark at 14,198.10. The Dow’s all-time high is huge resistance.

The February 18 Profit Radar Report referred to the all-time high resistance: “Next week has a bearish seasonal bias. With its all-time high just ahead, the Dow has a well-defined resistance level for a short trade. Aggressive investors may short the Dow close to its 2007 high with a stop-loss at 14,200.”

At the Profit Radar Report we call this kind of a trade a low-risk trade. Why? Because we were only 200 points or 1.5% away from the stop-loss level.

One Swallow Doesn’t Make a Summer

But one swallow doesn’t make a summer one one red candle doesn’t make a bear market. After two 90% down days (February 20, 25) stocks were likely to rally. That’s why Monday’s (February 25) Profit Radar Report recommended to cover short positions at S&P 1,491.

In addition the VIX triggered a sell signal (buy signal for stocks) yesterday. Although I think that stocks will slide to a lower low, it will take a break below support or a spike to resistance to place a possible short bet. Important short-term support/resistance levels are outlined in the Profit Radar Report.

IBM – The Dow’s Alpha Stock is on the Verge of Breaking Down

IBM is the Dow’s biggest powerhouse and one of the most important companies for the U.S. stock market. The blue chip has shot up 300% in four years and is sitting just above important support. A breakdown here could have far reaching ripple effects.

IBM is an “alpha stock.” Like an alpha dog or alpha male, alpha stocks lead the pack.

What makes IBM an alpha stock? There is IBM’s storied history and $217 billion market cap, but what ultimately makes it a leader is the 11.28% weighting it carries in the Dow Jones Industrials Average and Dow Jones Industrials Average ETF, also called Dow Diamonds (DIA). IBM is also the fifth largest component of the S&P 500 SPDR (SPY).

Unlike other indexes, the DJIA is price weighted, the pricier the stock, the heavier it’s weighted in the average. IBM trades at 190 and influences the Dow’s movements more than any other stock.

Only two other companies are as influential (or more influential) as IBM: Apple and Exxon Mobil. We know that Apple’s 30% haircut put the entire U.S. stock market in a funk, so what’s IBM’s message?

Long-Term Technical Outlook

IBM lost about 10% over the past three months. This sounds like a lot, but when put in context with a long-term chart, it’s no more than a drop in the bucket. Since November 2008, IBM soared from 69.50 to 211.79, a 303% increase.

The first quantitative easing (QE) intervention also commenced in November 2008, but surely any correlation between the two is purely coincidental. Regardless of the cause, the down side potential for a blue chip stock that’s tripled in four years is much greater than 10%.

Short-Term Technical Outlook

The short-term chart shows IBM toying with long-term (green trend line) and short-term support (black channel). A break below 190 would trigger a sell signal (stop-loss just above 192) with a possible short-term target of 177 – 182.

To me, the structure of the decline since the October high suggests that prices ultimately want to head lower. Trade above 190 allows for limited near-term strength, but only a move above 198 (channel rising) would unlock more bullish potential. A drop below 190, on the other hand, could be the straw that breaks the camel’s back.


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.

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.