By Mark Hulbert
The U.S. stock market is experiencing an unusual number of mixed trading sessions, in which one major index closes higher and another finishes lower. This is not a sign of a healthy market. That’s why the market’s big drop on the Friday after Thanksgiving was perhaps not as unexpected as it otherwise appeared.
Consider the divergences between the Dow Jones Industrial Average (DOW:DJIA) and the Nasdaq Composite Index (NASDAQ:COMP) over the four trading sessions before Thanksgiving. On each of those days, one of these indices closed up while the other closed down. On average over the four trading sessions, there was a one percentage point difference in their returns.
|DJIA % change||Nasdaq Composite % change||Difference (in percentage points)|
To analyze how rare such divergences are, I counted the number of times since the Nasdaq Composite was created in 1971 in which it closed up for the day and the Dow closed down, or vice versa. Such divergences occurred in 22% of the trading sessions, or about once every five days. So a run of four days in a row of such divergences is unusual.
Nor are those four trading days particularly unique nowadays. Over the trailing month, daily Nasdaq-Dow divergences have occurred 38% of the time. Their frequency was only slightly less over the trailing quarter, at 37%. Both of these figures are almost double the long-term average.
I also measured the magnitude of the difference in the daily returns of the Nasdaq Composite and the DJIA since 1971. The long-term average is 0.5, about half the 1.0 percentage point difference experienced over the last four trading days before this past Thanksgiving, on average.
To measure the significance of mixed markets, I measured the correlation between the Nasdaq Composite’s subsequent return and the frequency and magnitude of Nasdaq-Dow divergences. In both cases there was an inverse correlation: When divergences have been more frequent, and the magnitude of the divergences greater, the Nasdaq on average has tended to produce lower returns.
This inverse correlation was particularly evident at the top of the internet bubble, when the divergences reached an extreme. In the weeks leading up to the March 2000 bursting of that bubble, more than half the trading sessions saw the Nasdaq Composite and the Dow with mixed closes. The average daily spread in these two benchmarks’ returns approached 2.0 percentage points.
Any parallel to the bursting of the internet bubble is disturbing, of course. Though recent divergences aren’t as extreme as those seen in March 2000, they are nevertheless much higher than the norm, and a healthy market fires on all cylinders.
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