Recently, the Dow Jones has been outperforming the S&P 500. The study will demonstrate that the greater the outperformance of the Dow Jones vs. the S&P 500, the worse the intermediate term results for both indices.
The performance of the Dow Jones and S&P 500 has diverged. The Dow is making new highs while the S&P is struggling to surpass the highs made in October, November, and December 2o11.
I somewhat randomly chose the 30 day rate of change (ROC30) of the Dow Jones (DIA) and S&P 500 (SPY) to measure the difference in performance of the two indices. When looking at their charts, both indices appeared to have bottomed about 60 days ago. I just split the number in half. Unscientific? Maybe. I will take a look at the 60 day rate of change as well, but not in this post.
What does the outperformance by the Dow Jones mean over the intermediate term, if anything?
The Rules
Buy SPY or DIA at the close if
- The difference between the DIA ROC30 and the SPY ROC30 is greater than X.
- Sell at the close Y days later.
- No commissions or slippage included.
- All SPY and DIA history used.
The Results:
I know the graph is busy. Bear with me. We’ll start from top to bottom of the legend on the right side of the graph.
The white and pink lines show a small divergence between DIA and SPY where the difference between the two is more than 0.5%. Note that the average performance of both ETFs track each other fairly well and make several forays into positive territory.
Next are the blue and red lines. With the difference greater than 1%, we began to see the DIA (red line) outperforming SPY (blue line). This is not really ground-breaking. I think it just shows that the Dow’s momentum persists over the time period. Both ETFs finish in positive territory after 50 days.
As we examine the green and purple lines where the DIA’s ROC30 is 1.5% or more greater than SPY’s, performance begins to head into negative territory around the 17th day. While DIA still outperforms SPY, neither ETF manages to get back to positive territory.
Finally, the brown and orange lines show that as the DIA outperformance grows to 2% or more, performance over the next 50 days worsens.
What Does It All Mean?
I’m not sure. I’m not sure why performance for the differences of greater than 1.5% begins to drop around the 17th day. Perhaps when capital moves to the Dow it is a flight to safety, and after a month or so, whatever was perceived as risk has abated.
There were plenty of samples. Even the most restrictive requirement of > 2% still had 30 samples at 50 days out. When the divergence begins around the 17th day, there were 68 samples averaged to show the > 1.5% result.
The issue I can’t ignore is that it is pretty difficult to produce an average return for these ETFs that doesn’t finish in positive territory after 50 days. Markets have a tendency to go up, and most returns over 50 day periods will reflect this. I have looked at dozens of setups (if not a hundreds or more), and even when I was sure they were bearish over an intermediate term, most of the time the results showed they were in fact neutral to bullish. Therefore it is significant to me that the >1.5 and >2 setups both produce a negative return after 50 days.
Limitations
This is a very simple study. Perhaps I’ve lucked into something using ROC30. In a future study I will lengthen the ROC and see what happens. Also, I would like to require successive days where the difference is greater than X to see how that changes the results.
I welcome any thoughts and observations.
At first I thought the poor 50-day performance (for the brown and orange) might be related to the Dow being composed of large cap stocks, while the S&P includes both large and mid cap. But that’s probably not it.
Now I’m thinking two other possibilities:
1) the sectors that outperformed recently – staples, healthcare, utilities – may be overrepresented in the Dow, and this is where people go when they expect market turmoil.
2) The Dow is price weighted, the S&P is cap weighted.
Or maybe I have no clue….
Your comment “when capital moves to the Dow it is a flight to safety” is exactly what Richard Russell said many times. When people are worried they head to the biggest, most stable, most liquid names.
It’ll be interesting to see how this work correlates to the well-known January indicators. We’ll know in 30 days!
Bozo, I agree with your thinking in regards to #1. As for #2, that is a great point and I hadn’t considered how it may affect things.
As an aside, I meant to note in the article that the Dow logged 4 out of 5 days at the end of December where its ROC30 was 2% or more higher than the SPY’s.