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Chart 14.

The NASDAQ 100 vs. the Dow

The ratio between the NASDAQ 100 and the Dow has offered timely market signals over the past fifteen years (Chart 15).

The Dow consists of many different stocks, but on balance, they tend to be defensive, high yielding blue chips, while the NASDAQ 100 equities are growth-oriented. This means that when the NASDAQ is out performing the Dow, investors are optimistic and tend to push up equity prices in general. On the other hand, a falling ratio means sentiment has turned more cautious, which is negative for the market.

Chart 15.

Trendline violations and decisive KST reversals have often been followed by major reversals in both the ratio and the market. The only period when the ratio experienced anemic price action was between 1996 and 1997, but at that time there were no trendline violations to back up the signals. That’s certainly not true of the current situation, as the ratio has broken below an up trendline and its 12-month MA. In addition, the KST is also in a bearish mode, so consequently, the brief history of this relationship adds more fuel to the proverbial bearish fire that the whole market is likely to experience a major decline.

Leading Market Sectors and Divergences

We have already established that bond prices lead equity prices. For this reason, market sectors that are sensitive to interest rate changes often provide advance warning of impending trouble. One well-known relationship is the between the S&P and the Dow Jones Utility Average, shown in Chart 16.

Chart 16. Vertical lines show S&P composite peaks.

The vertical lines flag the bull market highs in the S&P. On most occasions the Utilities give us a warning by peaking ahead of the S&P, but sometimes that is not the case. For instance, in 1977 and again in 1994, the Utilities lagged the S&P. This didn’t make the situation any less bearish, just that Utilities didn’t offer their usual warning. This time, they peaked in September of 2005, well ahead of the high for the S&P, which was set in April 2006. Fair warning this time!