Indicator of the Week: Why Sentiment Matters After the Dow's Defeat of 18K

If history repeats itself, here’s what investors can expect as the DJIA flirts with 18,000

Senior Quantitative Analyst
Apr 20, 2016 at 7:00 AM
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The Dow Jones Industrial Average (DJIA) is once again flirting with the even 18,000 level. As you can see in the chart below, the index has struggled with this level in the past. These even levels can be psychological barriers that act as resistance for stocks when approached from below. They can also act as support once the level is overtaken.

Even levels are popular points for investors to assess the markets and establish demarcation lines of "expensive" or "cheap." Looking at the chart below, over the past couple of years it seems investors have established 18,000 as expensive ("so take profits here") and 16,000 as cheap ("so buy in right here"). This week, I'm taking an in-depth look at how the Dow has performed when approaching these even levels, and how sentiment has played a role.

                          DJIA Index even levels 

Dow Crosses Even Levels: The first table below shows how the Dow has performed after crossing above even 1,000 levels. I’m only looking at levels of 10,000 or more, and went back to 1999, the year the Dow first crossed 10,000. Also, the index had to be below the level for at least a month. 

The Dow tends to struggle when these even levels come into play. After topping these levels, the index averages a negative return over the next week and over the next three months. The other time frames also show underperformance in terms of average return and percent positive. Also notable is the standard deviation of returns. By this measure, volatility decreases after crossing even levels, indicating a tendency to chop around these levels.  
                                 Dow Jones indicator levels


Layering in Sentiment: Despite the strong rally over the past couple of months and the fact that the Dow is less than 2% away from all-time highs, the percentage of bulls in the Investors Intelligence (II) sentiment poll is below 50%. The tables below break down the returns of the Dow after crossing even levels by whether the percentage of II bulls is below 50% (like right now) or above 50%. The results are more encouraging when you take into account investor sentiment.

The average six-month return is negative in the first table, but that is skewed by a nearly 30% loss after a signal in April 2008, during the financial crisis. The three-month returns are pretty much in line with anytime returns (compare it to the table above) and the one-month returns are quite strong, with the DJIA averaging a gain of 1.25% and positive 75% of the time. 

When sentiment has been more optimistic (see the second table below), then crossing these even levels has been especially dreadful  for the Dow. But when there is relatively more pessimism, like right now, then these even levels have been much less of an obstruction. 

                        Dow Jones Indicator levels bull



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