Michael Santoli

What’s Been ‘Dogging’ the Dow During August Dip Could Now Be Nibbling at the Nasdaq

Michael Santoli

The Nasdaq today no longer looks beyond the bite of what's been dogging the Dow all month.

During the broad stock-market setback from all-time highs on Aug. 2, the Dow Jones Industrial Average has been by far the weakest of the widely quoted benchmarks – especially compared to the Nasdaq 100.

Even before Tuesday’s drop, following threatened U.S. military action in Syria and elevated political rhetoric in Washington over the approaching federal debt ceiling debate, the Dow had lost 4.5% since Aug. 2. The Standard & Poor’s, by contrast, was off 2.9% and the Nasdaq 100, represented by the PowerShares QQQ ETF (QQQ), was off a mere 0.3%. Tuesday's market activity changed that picture a bit, with the Nasdaq shedding 1.65% as the Dow sank less than 1%.

Through most of the year's rally, the Dow led all indexes into July on the strength of heavy investor demand for big, stable blue chip shares – such as those that might make up a Grandma’s portfolio.

The fact that the Dow is lagging in a weaker tape is a bit counterintuitive, given that its sort of diversified, mature, dividend-paying companies might normally be expected to provide decent defense at times of increased nervousness over economic data, the course of Federal Reserve policy and political risk. In today's selloff, this pattern has reversed a bit, with the Nasdaq losing 1.8% to the Dow's 0.9%.

There are a few things behind the Dow’s doggy action versus other market gauges:

First on the list is Apple Inc. (AAPL). The largest stock by market value that’s not in the Dow, and once again the most valuable company in the world, Apple shares have been rolling higher since bottoming below $400 in late June.

Just as sentiment was turning a bit brighter toward Apple as chatter spread of a new, cheaper iPhone and other new-product prospects, activist investor Carl Icahn tweeted news of a new stake in the company, prompting more “expert”-following traders to jump in. The shares bucked the pullback tide, rising 8.7% from Aug. 2 through Monday. Apple, which is down more than 2% Tuesday to below $500, makes up more than 20% of the Nasdaq 100.

Beyond Apple, seven of the 10 largest stocks in the Nasdaq not in the Dow – most, but not all of them tech stocks – have outperformed the broad market since the Aug. 2 peak.

A new core of cult growth stocks has emerged outside the largest names – companies that investors see as category-dominating, multi-year expansion stories reaping the benefits of social networks in one way or another. Facebook Inc. (FB), Netflix Inc. (NFLX), Priceline.com (PCLN) and LinkedIn Corp. (LNKD) are all up during the recent index decline, although feeling the pain today amid the broad market decline. In short, what the market has wanted lately, the Dow doesn’t have.

And, conversely, what the Dow has, the market has disdained. As a price-weighted index, in which stocks with higher nominal share prices have greater sway, the sloppy action in a handful of high-priced blue chips has taken a toll. Oil giants Chevron Corp. (CVX) and Exxon Mobil Corp. (XOM), consumer stalwarts Johnson & Johnson (JNJ) and Coca-Cola Co. (KO) and dividend-yield names Verizon Communications Inc. (VZ) and AT&T Inc. (T) have been conspicuous losers in August.

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Many Dow stocks had been bought by investors in search of “bond proxies,” stocks of mature, slow-growth companies that offer decent and growing dividends in a world of chronically low interest rates. In recent weeks, as Treasury yields ran up to two-year highs, the appeal of slim yield advantages offered by large-cap stocks has dimmed. Dow stocks are also the sort that foreign investors, who have been cycling capital into the relatively strong U.S. market, would buy - or, as they grow risk averse, sell.

While no one index or sector is a flawless bellwether for stocks, the market has broadly experienced a loss of momentum and some ragged internal action that has perhaps been better-captured by the Dow than the Nasdaq.

Though many market strategists are viewing this as a temporary pullback on the way back toward the old highs, and plenty of technical market analysts are taking heart in the resilience of industrial, small-cap and transportation stocks, the recent highs came on narrower leadership than did the May high.

The strength in that narrow group of growth darlings in the Nasdaq, then, may have been somewhat masking the emergence of pent-up selling pressure in recent weeks. Today's slide may be the evidence of this.

In several respects, a bit of weakness is perfectly logical. The market entered August having gained more than 15% this year, August and September are among the weaker months for stock returns historically, and there are a handful of universally known “uncertainty bombs” on the way.

Aside from the Fed’s September meeting – at which it may or may not elect to reduce its stimulus pace – Congress returns to the budget and debt-ceiling fights; the president is to nominate a new Fed chairman; interest rates have risen a lot in a short time; and Syria and Egypt are undergoing increasingly worrisome civil unrest that could lead to U.S. military action.

Probably the best thing the market has going for it is just how ubiquitously understood these “risk events” are. They might well provide plenty of good excuses for deeper downside movement in stocks, which after all are not broadly cheap.

Yet in each pullback of the past year, investor fear built up rapidly, turning market sentiment bearish – which is often exactly what helps halt declines, as the nervous money is shaken out of the market.

“After less than a five-percent drop, fear has spiked significantly,” says Ryan Detrick of Schaeffer’s Investment Research. He cites a storm of buying in CBOE S&P 500 Volatility Index instruments that represent bets on a surge in market anxiety and jumpy prices. The weekly poll of financial advisors by Investors Intelligence also shows a crowded contingent has already turned cautious.

It’s not yet clear that the mood has turned into an outright investor scare episode; there are plenty betting this is another buyable dip and the Fed will turn out to be more friendly than not next month. But the next week’s worth of sentiment clues could determine whether, once again, investor worry has welled up enough to earn stocks the benefit of the doubt again.

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