What The Dow Is Telling Us

When people refer to “the market”, they generally mean the Dow Jones, despite that index’s very narrow representation of the stock market.  As most know, much of the more robust American companies are not represented in the Dow Jones, but rather in the broader Nasdaq or S&P indices.

Nevertheless, the position of the Dow Jones index is an important bellwether for the health of both the stock market and for the overall economy.   Since the dramatic, sudden selloff in the stock markets in February of this year, we’re assessing the condition of certain Dow components to gain some insight on what to expect in the next few  months.

While the market recovery has been strong and all of the components are well off their lows, dowjonesit’s interesting to note that 18 of the 30 are still trading below their 200 day moving averages.  If you add the 3 that are only at their 200 day lines,  we may be surprised to learn that just over 2/3rd’s of the Dow stocks are not in what is classically considered a bullish phase.   More significantly, of the ones that are trading below their 200 day averages, their associated indicator lines are sloped downwards which means that price moves towards the averages are against the longer term trend.

Defense, energy, pharma and banking have been notable laggards while other industrials such as MMM and PG have been only average.

Given the strong moves by certain well known issues in the broader market, many of which have made new all time highs, this is a concern.  We conclude that much of the Dow Jones components are in a holding pattern at best. The Dow index itself is only hovering right at this moving average after a brief period trading above it.  AAPL and MSFT are represented in the Dow Jones and have skewed this price weighted index.

The big winners over the last few months are “new normal” companies such as AMZN, NFLX, NVDA, TSLA, SHOP to list a few, are not represented in the Dow.

There are two schools of thought as to how to interpret this reality.  One is that the lagging stocks represent opportunities that will blossom as the economy continues to expand.  The other thought is that many of these stocks will continue to be poor performers relative to the many newer companies operating in new spaces.  We had earlier discussed the notion of rotation in which different market sectors will lead as an economy travels through its cycle.  My feeling is that what we are observing is not a normal rotational cycle.

It’s clear that we are in the midst of a shift towards companies that have and will continue to benefit from a new reality as a result of political forces rather than classic supply/demand ones.   As a simplistic illustration, people still need to eat, but instead of going out to eat, their activities are limited to take out mechanisms.  Consequently a company such as DRI, which reflects the dine out restaurant business continues to languish even as people continue to find alternate ways to consume food.  If this reality continues, there will certainly be implications for real estate trusts and property companies.

Political inputs can change unexpectedly and thus sudden shifts in business trajectories can result.  As an example, if political lockdowns end, can we expect NFLX,  ZM and AMZN to continue advancing?  Would the fortunes of airlines, UAL, AAL and other travel related consumer companies change also? Of course.   These are examples of companies that are driven by current circumstances which are vulnerable to unknowable policy changes.

It would be difficult to extrapolate earnings into the future for any company when the future which can be quite capricious, thus earnings forecasts are likely not a good yardstick to determine stock valuations.  The unknown of the coming US elections is another wild card.

Thus, the best we can do is to observe and monitor the indicators of trend to determine whether the environment for investing is friendly….or not.  While the high beta stocks continue to advance, ebbs and flows do occur, so prices should not be chased based on imagined scarcity.  Valid entry points will emerge based on risk reward parameters.  On the flip side, stocks that have had strong moves will also signal pauses in their trajectory and we can try to determine those points of inflection by divergence clues.

To hijack a current expression these days, stock charts matter.




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