Dump the Dow, Stock Market Bullish Trend Under Growing Pressure

By: Peter_Navarro

My crusade this week is to get financial analysts to stop focusing on the Dow Jones Industrial Average is the most important symbol of the US stock market. In the ticker tape parade everyday on CNBC, I would much rather see the S&P 500, the NASDAQ, and the Russell 2000 rather than the Dow.

The Dow is only 30 stocks and most have a lot of international exposure so the index is hardly reflective of the state of the US market. In contrast, the S&P 500 is the broadest measure of the US stock market, the NASDAQ gives us our best snapshot of technology, while the Russell 2000 provides the best glimpse of future growth and productivity as measured by the ability of the small-cap US economy to bring forth innovation.

I am up on my soapbox this week about this because if you have been watching the Dow exclusively, you have been seeing quite a different picture of the market than if you have been watching the three other indices. The fact of the matter is that the Dow has been doing better than the S&P 500, NASDAQ, and the Russell 2000; and in some ways, the Dow's relative outperformance has been lulling the Bulls into a false sense of security. This extended passage from Market Edge provides an interesting interpretation of the Dow as it relates to any confirmation of the market trend:

[T]he DJIA posted another new recovery high while the broader indexes failed to confirm the move. This has been the case over the last three weeks and doesn't bode well for the market going forward. A confirmed high occurs when the DJIA records a new closing high which is accompanied by a majority of the broader major averages also posting new highs. It is especially important that the NYSE A/D line and the number of NYSE 52-week new highs confirm the move.

Since closing at 9712.73 on 10/30/01, the DJIA has recorded six new recovery highs. The high on 11/16/09 (DJIA 10406.96) was the closest to being a confirmed high as four of the nine broader indexes followed suit. When the DJIA closed on 11/23/09 at 10450.95, none of the broader indexes posted a new high. Also, the NYSE A/D line is off by over 1600 units from it's high recorded on 10/19/09 while the NASDAQ A/D line is some 8000 units below it's 10/14 high. This divergence is why the Momentum Index is so negative. The fact that there has been six non-confirmed highs over the last three weeks without a sell off is very unusual. It is like stretching a rubber band. At some point it should snap. [Emphasis added]

Given my long-standing concerns about the macro fundamentals of the US economy -- high unemployment, rising oil prices, a housing market still in disarray, looming crushing budget deficits at both the state and federal level, and the debasement of our currency by the Federal Reserve -- and given the bearish technical conditions of the US markets, my strategy remains largely one of holding cash.

That said, at the beginning of the last week when the market popped up on Monday, I "sold the rally" by opening a small short position in TWM -- the ultrashort exchange traded fund for the Russell 2000. Loyal readers will know that this is my favorite shorting instrument because of its volatility and the tendency for small caps to lead the market either up or down.  If the market heads down, as I believe it will, I will add to this position. If the market heads back up, I will simply close my TWM position at my original purchase price and thereby incur no loss -- I'm now playing with the house's money.

I see this coming week as a showdown of sorts. The debacle in Dubai is a fresh reminder of the fragile state of many countries around the world still working off their credit crisis karma. We will get a good look at the consumer spending patterns for the holiday -- we can bearish are strong and bullish. We should also see some resumption of volume in this market. This is important because over the last month volume has been very unusually low.

With the trend remaining a flip of the coin, the best strategy in this market may well be to be primarily in cash. However, I've also come up with an interesting strategy for more aggressive traders that is featured this week in a video I produced for the Street.com. In a nutshell, the "long-short" strategy involves a basket of six stocks drawn from the IBD 100. The long stocks include BUCY, EPAY, and CTRP.  The short stocks include ININ, TNS, and EJ.  Check out the video as you may find this to be a really interesting strategy. This strategy will only work, however, for traders who know how to manage risk, cut their losses, and employ trailing stops.

Professor Navarro’s articles have appeared in a wide range of publications, from Business Week, the Los Angeles Times, New York Times and Wall Street Journal to the Harvard Business Review, the MIT Sloan Management Review, and the Journal of Business. His free weekly newsletter is published at www.PeterNavarro.com.

© 2009 Copyright Peter Navarro - All Rights Reserved
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