DJIA Underperforming Small Caps A Blessing, Not A Curse
By Rocky White
Over the past couple of months, the Dow Jones Industrial Average (and DIA ETF) has significantly underperformed the other indexes. The Dow is the most noted market index, and is composed of 30 of the largest companies based in the United States. Some pundits have mentioned that the recent weakness in the Dow is a sign of some underlying weakness in stocks in general, and therefore advise caution. In the analysis below, I go back to 2000 and look at the performance of the Dow compared to the small-cap Russell 2000 Index (RUT) which can be tracked by the IWM ETF to find out what it means when these two indexes diverge.
Dow vs. RUT: For this study, I calculated the two-month relative strength of the RUT compared to the Dow. Then I found the returns for the indexes going forward, depending on the relative-strength readings. The chart below shows the RUT since 2000. You can see that relative strength surpassed 1.05 this month, meaning the Dow has been underperforming. The green dots mark other times this has happened. The red dots mark the times that relative strength fell below 0.95, meaning the Dow significantly outperformed the RUT.
The first table below shows returns after the Dow underperforms the small-cap index, just as it is right now. Looking at returns over the next six months, the RUT gained an average of 1.22% and was positive 56% of the time. The Dow gained an average of 1.89% and was positive 75% of the time. The six-month performance of the indexes is not anything special, but it doesn’t seem to indicate any underlying weakness in stocks. Actually, it might be an indicator to shift some money to big-cap names, as the Dow does better than the small-cap index.
The second table shows how the indexes have done when the Dow significantly outperforms compared to the RUT. That’s actually the scenario where there seems to be some general weakness in stocks. Six months after these occurrences, the RUT averaged a 1.00% gain but was positive just 38% of the time. The Dow averaged a loss of 0.68% and was also positive just 38% of the time. According to this study, we’re better off with the Dow underperforming smaller companies rather than the Dow outperforming.