This Stock Alarm Also Sounded Around Black Monday and the Dot-Com Drop

The Dow is headed for a huge weekly gain, while the Nasdaq is still lower on the week

Nov 30, 2017 at 1:24 PM
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The Dow Jones Industrial Average (DJIA) is set to wrap up an eighth straight monthly win, which would mark its longest monthly win streak in more than 20 years. The index today climbed north of the 24,000 level for the first time ever, and is on pace to end the week with a healthy gain of more than 2.5%. However, while the Nasdaq Composite (IXIC) is in rally mode today, the tech-rich index suffered its worst session in months on Wednesday, and remains on pace for a weekly loss -- which would send up a signal not seen in 15 years. Below, we take a look at what this rare blue-chip/tech divergence could mean for the stock market.

Previous Signals Sounded Around Black Monday, Dot-Com Bust

The last time the Dow was up more than 2% on the week at the same time the Nasdaq was in the red was July 2002, according to Schaeffer's Senior Quantitative Analyst Rocky White. Since 1972, there have been just 16 other signals of this kind. Half of those signals flashed between 1999 and 2002, when the dot-com bubble was deflating, and two of the signals happened in 1987 -- the year of Black Monday.

divergence signals dow returns

divergence signals nasdaq returns

Nasdaq Could Underperform Over Next 6 Months

One month after the previous signals, both the DJIA and IXIC underperformed. Specifically, the Dow was down 0.1%, on average, and was higher just 43.8% of the time. That's compared to an anytime average one-month gain of 0.63% since 1973 (when the first signal flashed), and a win rate of 59.4%. The Nasdaq was down a whopping 1.75%, on average, a month after a signal, and was positive just 37.5% of the time. That's compared to an anytime average one-month gain of 0.85%, with a 60.6% win rate.

After that, though, is where the tech-rich IXIC really starts to underperform -- both itself and the Dow. While the DJIA was up an average of 3.47% three months after a signal -- compared to an average anytime gain of 2.07% -- the Nasdaq's average post-signal gain of 1.51% is much less than its average anytime three-month return of 2.89%. And while the Dow's average post-signal six-month return of 3.35% is slightly less than its average anytime gain of 4.22%, the IXIC was down 0.28%, on average, far underperforming its average anytime six-month gain of nearly 6%!

It's also worth noting that volatility in the tech sector could ramp up, if past is prologue. The Dow's post-signal standard deviation is roughly in line with the norm, while the IXIC's is notably higher than usual at the one- and six-month markers. In fact, a month after the past 16 signals, Nasdaq standard deviation was 10.5% -- nearly twice its average anytime standard deviation.

dow returns after ixic signal

ixic returns after dow signal

In conclusion, if past is prologue -- and if the IXIC ends the week with a loss -- the Nasdaq could continue to lag the Dow over the next six months. In the near term, however, the index has a couple of potential support levels below, at 6,830 and 6,725 -- the site of trendlines connecting higher highs and higher lows, respectively. And, should both the Dow and IXIC take a breather over the next month, as they've done after prior divergence signals, "short covering will keep pullbacks in check," per recent commentary from Schaeffer's Senior V.P. of Research Todd Salamone.


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