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Oct. 3, 2018, 5:31 p.m. EDT

A disconnect between the Dow and the broader market could spell trouble for stocks

The stock market is being driven by a few good stocks

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By Sue Chang, MarketWatch


MCT via Getty Images
The Dow is bucking the trend.

The juggernaut that is the Dow Jones Industrial Average closed at a record for the 15th time this year on Wednesday even as overall market breadth suffered, signaling a potential rough patch for U.S. stocks, according to one well-respected technical analyst.

Jason Goepfert, president of Sundial Capital Research, tweeted out the following chart to show all the times the Dow bucked the prevailing market trend to end at a 52-week high over the past 25 years. The most recent incidence was on Tuesday when the Dow rose to its 14th record finish of the year while the S&P 500 and the Nasdaq remain stuck in red.

The Dow /zigman2/quotes/210598065/realtime DJIA -0.95% has defied the crowd in this manner 31 times since 1993, with several occurrences clustered in 1999.

This disconnect between the benchmark and market breadth tends to happen when the major indexes are driven by a few good stocks. It’s also worth noting that breadth is often influenced by small-caps and interest-rate sensitive shares, Goepfert said.

The breadth problem is not just limited to the Dow. Strategists at Bespoke Investment Group on Tuesday pointed out that even though the S&P 500 /zigman2/quotes/210599714/realtime SPX -0.39%  rose in September, the average stock in the large-cap index slipped 0.06%, a result of larger stocks outperforming smaller issues.

In fact, the 50 largest stocks in the S&P 500 rose an average of 1.18% last month, while the next 100 largest stocks also posted decent gains. In comparison, the smallest stocks either fell or were relatively flat.


Bespoke Investment Group

Case in point, Apple Inc. /zigman2/quotes/202934861/composite AAPL +0.48% , Amazon.com Inc. /zigman2/quotes/210331248/composite AMZN -1.68% , Microsoft Corp. /zigman2/quotes/207732364/composite MSFT -1.63% , Alphabet Inc. /zigman2/quotes/205453964/composite GOOG -0.60%   /zigman2/quotes/202490156/composite GOOGL -0.67% , and Berkshire Hathaway Inc. /zigman2/quotes/200060694/composite BRK.B +0.07%   /zigman2/quotes/208872451/composite BRK.A +0.02% , the top 5 stocks by market capitalization, all posted double digit growth this year with Amazon skyrocketing 68%.

At the other end of the spectrum, Stericycle Inc. /zigman2/quotes/202722990/composite SRCL +1.66% , Quanta Services Inc. /zigman2/quotes/203420082/composite PWR +2.34% , Mattel Inc., /zigman2/quotes/209819189/composite MAT +0.94% , H&R Block Inc. /zigman2/quotes/207406664/composite HRB -1.85%  and Brighthouse Financial Inc. /zigman2/quotes/205830158/composite BHF -0.12%  have all posted losses in 2018.

Further illustrating the divergence, the S&P 500 is up 0.8% while the small-cap Russell 2000 /zigman2/quotes/210598147/delayed RUT -0.41%  declined 4% over the past month.

And the significance of these contradictory moves is that they are usually followed by market corrections, according to Goepfert.

“While the major indexes continued higher for a while in 1999, it was the last gasp before a bear market,” he said. “In 2007, a bear market followed almost immediately.”

The technical analyst played down the possibility of a bear market this time but predicted that returns are likely to be muted in the coming months.

“When we’ve seen these kinds of ‘split’ breadth conditions in the past, the risk/reward in stocks was unfavorable over the next 2-12 months,” Goepfert said.

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Sue Chang is a MarketWatch reporter in San Francisco. You can follow her on Twitter at @SueChangMW.

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