Major U.S. Indexes Suffer Bearish Breadth Divergences

Purely judging on price, the major U.S. indexes did well in November. And while price is what matters, there were subtle signs of internal weakness, not visible to ‘price watchers.’ Here’s why those signs of weakness just started to matter.

Price is always the final arbiter and thanks to the Federal Reserve the markets can (and will) stay irrational longer than investors can stay solvent.

However, price is not the only thing that matters and often a look under the market’s ‘hood’ pays.

In recent weeks we’ve seen a few covert cracks in the bull’s armor.

1) The percentage of S&P 500  stocks above their 50-day simple moving average (SMA) has fallen from 87% on October 22 to 75.5% on Friday.

2) The number of new Nasdaq (Nasdaq: ^IXIC) highs dropped from 445 on October 18 to 338 on Friday (there were only 182 yesterday).

Breadth divergences like that don’t happen overnight and don’t cause stocks – in this case the S&P 500 and Nasdaq – to drop overnight. It’s a process that takes days and more commonly weeks.

That’s why, despite weakening participation, the Profit Radar Report maintained its up side targets of 1,810 for the S&P 500 and 16,150 for the Dow Jones (the Profit Radar Report recommended to close out long positions at S&P 500 1,810 and go short at Dow Jones 16,100).

What’s so special about Dow 16,150?

If you’ve been reading my articles, the chart below is old news.

This Dow Jones (DJI: ^DJI) monthly bar chart shows a 13-year trend line, which the Dow tagged on Friday.

Breadth divergences, like the ones mentioned above, reveal market weakness and caution of some sort of correction. But when does the correction actually materialize?

Resistance levels like the one illustrated in the long-term Dow Jones chart help identify the most likely ‘point of recognition,’ the price levels where bearish divergences are likely to turn into corrections.

Resistance levels (like the above or Fibonacci resistance, supply/demand resistance, head-and shoulders resistance) can act like a financial GPS that provides the most likely digits for a turn.

Of course, it may be pre-mature to write about a direction. One down day doesn’t make a trend and the Profit Radar Reports uses stop-loss levels (in this case for our Dow Jones short position) to protect against the ‘unexpected.’

Ongoing analysis for the S&P 500, Dow Jones and Nasdaq is available to subscribers via frequent Profit Radar Report updates. Each update is in depth but concise with actionable ideas.

 

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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.