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Comment: The Dow and Nasdaq are diverging. Why is that honey for the bears on the stock market

That’s not a good indication of a wide discrepancy between the Dow Jones Industrial Average
+ 0.90%

and Nasdaq Composite Index
+ 1.31%

has become almost universal.

Consider the number of sessions in which there is at least one percentage point difference between the returns on these two indices. We spent two such days just this week. On Tuesday, the Nasdaq was up 1.1% while the Dow fell 0.2%. In Wednesday’s trading, the opposite happened, with the Nasdaq down 1.0% and the Dow up 0.2%.

Such widespread discrepancies throughout history are quite rare. Since the Nasdaq Composite was created in the early 1970s, only 12.8% of trading days have experienced as big a divergence as investors did this week. In fact, so far this year, the rate of these 1.0% surplus divergences is 34% – almost three times greater. As you can see from the chart below, this year’s percentage is the highest expected in a record in years involving the internet bubble.

It’s a discount parallel, for sure. To go beyond the accompanying chart, I have been analyzing all the trading sessions of the US market since the early 1970s. Specifically, I calculated the correlation between the number of divergences greater than one part. percent over the next six months and the stock market profit for the next six months. Certainly, there is an inverse correlation – with the number of higher divergences associated with lower then lower returns.

Interestingly, this inverse correlation appears in the data regardless of the divergence produced because the Nasdaq Composite outperformed the DJIA or vice versa. Divergence itself appears to be a bearish trend.

I have noted these divergences in one Barron’s column a month ago, and then speculates that the reason they are down is that a healthy market is one that is shooting at all the poles. Since then, I realized that an even more important reason was that divergence was a symptom of late bull market speculation from retail investors. The typical retail investor is more interested in the companies that dominate the Nasdaq Composite than the blue chips found in the DJIA. So, as retail volume increases, the Nasdaq Composite’s volatility increases more than that of the DJIA.

And certainly retail volume is increasing strongly. Charles Schwab, a giant discount broker, Earlier this week reported that it added 3.2 million new accounts in the first quarter, more than in 2020. Barron’s It is estimated that the Robinhood app was downloaded more than 3 million times in January alone.

However, whatever the source of the DJIA-Nasdaq divergence, my data shows that they are more bearish for the Nasdaq Composite than for the DJIA. So one possible response to the growing number of wide divergences is to tilt your equity to the large-cap high-quality stocks that are dominating the DJIA.

But the broader investment lesson of being a market of the highest importance is not uncommon.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at [email protected]

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