Indicator of the Week: What to Expect as Dow 18K Looms Again

Will 18,000 act as a headwind for the DJIA again, or will 19,000 emerge as a magnet?

Senior Quantitative Analyst
Nov 4, 2015 at 7:28 AM
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The Dow Jones Industrial Average (DJIA) is approaching 18,000 again, which has been a problem area for the index going back almost one year exactly. It might be a good idea to keep these even levels in mind. These even levels are psychological areas, which are popular points for investors to reassess their market outlook. This can result in these even levels being significant areas of support or resistance, or potential magnets for the index.

The first chart is the Dow since 2014, and it's a good example of what I'm talking about. Here is a possible narrative on what has occurred (I know there are too many variables to boil the narrative down to just one story. I'm not saying this is the narrative, but perhaps a contributing factor).

Investors in early 2014 saw 16,000 as a good value to buy stocks. Therefore, the fall below this level was quickly regained, and then that level acted as support just after April. Then the Dow steadily went to the next even level of 17,000, at which point investors thought it might be getting a little frothy. That became a common area to unload some stocks. Thus, it struggled at this level on two separate occasions between July and October 2014. Just after October, the index fell toward 16,000 one more time, which was looked at as a steal by investors who rapidly bought up shares, pushing the index back over 17,000.

This time, though, that level wasn't considered so expensive. The market had a lot of momentum, in addition to the fact it had already hit that level several months before. It quickly moved toward 18,000, another even level, at which point investors assessed their positions. The Dow bounced around there for some time, before the collapse in August, toward that "cheap" 16,000 level. Again, strong buying occurred, and 18,000 became a magnet for the index.

151103IOTW1

That's where we are now. The question is: Will traders reassess the market here and believe it to be expensive again, leading to some underperformance -- or, perhaps, will they reason that we were at the 18,000 level a whole year ago, and it's time the market grows again? In this case, 19,000 could be a magnet, and we'll soon be there. Below, I quantify how the market has behaved around these even levels.

Crossing Even Levels: The first table below looks at how the Dow has performed after crossing above one of these even levels after spending at least a month below. These even levels have been pretty dreadful for the index. Over the next six months after hitting one of these levels, the Dow has averaged a slight loss, and was positive barely half the time.

By contrast, per the second table below, the Dow's typical six-month return since 1999 (the first time it crossed 10,000) has been 2.27%, and it has been positive 65% of the time. The underperformance occurs in very short time frames, as well. Additionally, look at the standard deviation of returns. The comparatively lower standard deviations indicate a lot of sideways action when hitting one of these even levels. (See the Dow chart above around 18,000 over the past year.)

151103IOTW2

According to the analysis above, 18,000 might be a headwind for the Dow going forward. However, I'm not giving up hope that 19,000 becomes a magnet for the big-cap index.
 

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