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Investment

The Dow soars but other gauges are down: explaining this market's strange divergences

The financial markets are acting really wacky right now. There are some very strange divergences going on.

Here are just two that really stick out:

1) The Dow has been a monster in the past couple of weeks, but everything else is flat to down. You can blame this on the way the Dow is constructed, the improvement in the global economy and the weaker dollar.

Dow’s 10-day win streak
(since July 24)

Dow: up 2.8 percent
S&P 500: up 0.5 percent
Dow Transports: down 1.5 percent
Russell 2000: down 1.7 percent

The Dow is up 2.8 percent, but the small-cap Russell 2000 is down 1.7 percent? That’s a bit odd.

There are three likely reasons for this:

First, the Dow is a price-weighted index, so the highest-priced stocks move the index more than the lower-priced stocks (the S&P 500 and most other indices are market-cap weighted indexes).

Recently, higher priced stocks have been bigger movers and are pushing the Dow around. For example, the Dow has moved a little over 600 points since July 24. The highest-priced stocks — including Boeing, Goldman Sachs, UnitedHealth, Apple and Home Depot — have moved significantly in that time.

Dow biggest contributors
(since July 24)

Boeing: 32 percent
Goldman Sachs: 17 percent
Home Depot: 10 percent
Apple: 8 percent
United Health: 5 percent
Remainder: 29 percent

Only 3M — another of the highest priced stocks — hasn’t been a big mover recently.

Second, the global economy has been doing very well this year, and many of the Dow members get a significant amount of their revenue outside the United States. Here are just a few examples:

Global exposure game
(percentage of revenue from outside the US)

McDonald‘s: 66 percent
Apple: 65 percent
American Express: 61 percent
Boeing: 60 percent
3M: 60 percent

Source: FactSet

Third, the dollar has dropped more than 5 percent since the start of the second quarter, which is a major tailwind for company earnings overseas.

The S&P of course, also has these stocks, and that index benefits as well, but with 500 stocks the S&P has many more companies that are in the mid-cap and even small-cap universe that don’t benefit as much from overseas growth.

2) Crude has been rallying, but oil stocks are not participating. Oil stocks are tightly tied to the price of oil, but that has been decoupling recently:

Crude oil vs. oil stocks
(since July 24)

Crude oil: up 6.7 percent
E&P ETF (XOP): down 2.7 percent

There’s an obvious reason this is happening: oil has been a huge disappointment this year. Analysts had confidently predicted oil would be close to $60 by the third quarter; instead, it has been mired in a $45 to $50 trading range, and dipped as low as $42 in the middle of June.

As a result, analysts have been aggressively taking down third quarter earnings estimates for oil stocks. At the beginning of April, earnings were expected to be up a whopping 222 percent for the period ending Sept. 30, but now they’re expected to be up only half that:

Q3 Earnings: Energy Earnings

April 1: up 222%
July 1: up 186%
August 8: up 132%

Source: Thomson Reuters

Yes, earnings estimates typically come down a bit going into the quarter because analysts are overly optimistic, but not by 50 percent. That is huge.

Once again, oil stocks are presenting a huge buying opportunity for investors. But having been badly burned already this year, they appear to be attracting far fewer buyers. The last time oil stocks rallied off their lows — it was early June — a notable inflow of money went into oil ETFs as investors bet that oil had finally bottomed around $45.

Wrong! Oil dropped to $42, and investors who bought in early June were selling by the end of the month.

Now oil is rallying again, this time toward $50. But oil stocks aren’t following. Given what has happened this year, who can blame investors for staying on the sidelines?

Source: Investment Cnbc
The Dow soars but other gauges are down: explaining this market's strange divergences

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