The first step in navigating the current market is to ignore the Dow Jones Industrial Average. The DJIA is not accurately reflecting what is going on in this market and will lead you to ignore broader weakness that has taken hold.
While the DJIA is up 0.22% the last two days, the Nasdaq Composite is down 2% and small-caps have fallen 0.9%. Breadth has been poor and the majority of stocks have suffered losses. Some of the losses in individual stocks have been quite large.
The DJIA always has been the most misleading of the major indices, but the business media has used it for so long that they have created the impression that it is a proxy for the overall market. The DJIA uses price weighting rather than capitalization weighting like all the other major indices. In other words, the stocks that influence the DJIA the most are those that have a higher price rather than those that have the biggest market value. There is no logic to that approach, but that is how it always has been done.
Because of its failure to accurately indicate what is really going on in the market, the DJIA is not used by institutions as a benchmark. Most large fund managers use the S&P 500 instead, which usually is more reflective of overall market action.
However, the S&P 500 also can be quite misleading. When there is a large amount of rotational action such as we've seen the last two days it can show better relative strength. especially when it is big-cap names that are favored. The S&P 500 is capitalization-weighted, so a handful of large stocks such as Apple Inc. (AAPL) , Microsoft Corp. (MSFT) , Berkshire Hathaway Inc. (BRK.B) , Johnson & Johnson (JNJ) and Exxon Mobil Corp. (XOM) will offset the movement of a hundred smaller stocks.
The important issue here is that we focus on the action in individual stocks we own and not be misled by the indices. Since the bull market began back in 2009 there have been several stealth corrections where many individual stocks and sectors have fallen sharply but the indices have held up well. It is easy to miss some big problems if you are simply watching the DJIA.
The thing that can be particularly frustrating with the DJIA is that it makes a bad day feel much worse when it doesn't reflect the real action. Yesterday there were many poor jokes by traders about how everything must be fine since the DJIA was in positive territory.
If we ignore the DJIA, the action in the market over the last two days takes on a different complexion. There was some very broad weakness, and support levels fell for key stocks in groups such as technology, semiconductors and biotechnology. The stocks that have been leading the market in August were the ones that suffered the most. Rotation into some industrials and growth names covered it up, but if you didn't play defense you very likely took some hits.
We have another soft open on the way. The bears typically have not done a good job of building downside momentum, but the dip buyers are now looking a little hesitant.
My game plan is to focus on capital preservation and avoid further downside. I'll be watching for entries into some favorite names as they pull back to support levels, but I'm more concerned about avoiding losses than producing gains right now.
