Indicator of the Week: 2 Reasons to Be Cautious Right Now

The DJIA has been eyeing the ultra-even 20,000 level in recent weeks, while bullish II sentiment nears an extreme

Senior Quantitative Analyst
Dec 28, 2016 at 7:30 AM
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Even levels on popular indexes are an interesting phenomenon. Psychologically, they are often markers at which the index is deemed expensive or cheap. Technically, they are popular points at which to take profits or buy more shares. For almost two years, the Dow Jones Industrial Average (DJIA) has struggled with the 18,000 level, getting knocked down to 16,000 on two separate occasions. Investors must have viewed 18,000 as expensive and 16,000 as cheap. The Dow made one final move down to 18,000 last month and has now surged to within striking distance of the 20,000 level. This week, I'll take a look at how the Dow has performed in the past after hitting these even levels. Also, this isn't just another even 1,000-point interval level, but a 10-millennia level! (I don’t know of a word that means 10,000 years.)

Daily Chart of Dow December 27

Running Into 1,000-Point Intervals: The first table below shows how the Dow has performed after running into a 1,000-point interval level of 10,000 or more. For a signal, the index had to be below the level for at least a month before crossing it on an intraday basis. The returns after a signal are not as good as typical market returns. This supports the notion that these round-number levels are significant points of resistance in the short term. 

Dow returns after 1000 point interval

Even Levels & Investor Sentiment: One gauge of investor sentiment is the Investors Intelligence (II) weekly sentiment poll. It's a compilation of investor newsletters and emails, which the editors at Investors Intelligence gather to determine the percentage of investors that are bullish, bearish, or predicting a correction. For today, I'm focusing on the percentage that are bullish. It's at about 60% -- the highest reading in over two years. As contrarians, the optimistic tone from investor newsletters would give us pause, and the numbers seem to validate these concerns.

Looking at the returns after the Dow crosses an even 1,000-point level -- specifically, 10,000 or greater -- I grouped them by whether the percentage of bulls in the poll was over or under 50%. When you look at the summary of the returns below, you see stocks do much better when the Investors Intelligence poll shows fewer than 50% of newsletters are bullish, at least when you get past the first week. The fact we're running into a psychological resistance point and optimism is getting to be quite high are two reasons to be cautious right now, at least in the short term. 

dow returns after 1000 point interval with II bulls

An Ultra-Even Level: I mentioned earlier that 20,000 seems even more significant than other intervals. The table below shows the Dow returns after it first touched each of the 1,000-point levels. I highlight 1,000 and 10,000, as they compare to 20,000 in being an ultra-even level. We haven't quite reached 20,000 yet, but it might be notable that the largest one-week drop in the table below happened after the Dow crossed the ultra-even level of 10,000. The Dow fell 2.6% over the following week. However, by a month after hitting that level, the index had gained 5.4%. 

dow after first crossing 1000 point interval

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