Mark Hulbert
2 min read
The performance difference between the Dow Jones Industrial Average DJIA and the Nasdaq composite COMP points to well-above-average odds that a bear market is imminent for U.S. stocks.
Look at how the Dow trounced the Nasdaq composite over the seven trading sessions through June 25. The Dow rose 0.5% in this period while the Nasdaq composite fell 5.0% — a cavernous 5.5 percentage-point spread.
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Only about 1% of the days since the Nasdaq composite was created in 1971 have experienced a greater trailing-seven-day spread, and many of those occurred prior to a major bull-market top.
A good illustration is what happened leading up to the top of the internet bubble in March 2000. Over the 10 trading sessions immediately before the day of the absolute top, seven sessions saw divergences as large or larger than last week’s divergence. In the bear market that followed the 2000 top, the Nasdaq composite lost almost 80%.
Not all past divergences triggered bear markets immediately. But 66.9% of the time since 1971, stocks were in a bear market within three months whenever there was a Dow-Nasdaq divergence as large as the current one. That’s a significant increase over what we would expect if wide divergences occurred randomly, since bear markets have occurred just 24.8% of the time since 1971.
These statistics suggest that some analysts may be kidding themselves — and us — when they argue that the Nasdaq composite’s recent drop is healthy — nothing more than a normal bull-market rotation between sectors. This argument would rest on more solid ground if only small divergences existed between the blue-chip-dominated Dow and the tech-heavy Nasdaq. That’s because tiny divergences are entirely normal and carry little, if any, market-timing significance. But the current divergence is hardly small; it represents a nearly three-sigma event.
This analysis doesn’t amount to a guarantee that a bear market is imminent. And there is nothing magical about a seven-trading-day look-back window when calculating the divergence between the Dow and the Nasdaq composite. The broader point is that a healthy stock market is one that’s firing on all cylinders — and this is not the case right now.
So pay close attention in the coming days and weeks to the difference between the Dow and the Nasdaq composite. If it persists, you may want to take some chips off the table and/or buy hedges as portfolio insurance.
