Introducing: "The Dow Fab 5 Indicator"

JC Parets
July 18, 2018

One of the most underrated tools we have as U.S. Stock Market participants is the Dow Jones Industrial Average. I often hear how because it's price weighted, or because it only has 30 stocks, it cannot be relied upon as a gauge of market health. In the past, I've written about how I use it and why these criticisms are irresponsible. I encourage you to read through our Free Educational section to see how we use the Dow Jones Industrial Average and other various tools that we have at our disposal.

One of the things I try and point out is that the S&P500 and Dow Jones Industrial Average move together. Look at a chart of both of them going back 10 years or 100 years and tell me they move in different directions. The S&P500 is market-cap weighted, meaning that the bigger the stock's market cap, the heavier the weighting in the index. The DJIA is price-weighted, meaning that the higher the price of the stock, the heavier the weighting. Regardless of their construction, the positive correlation is through the roof, which is my point here.

I want to take this strategy to another level today and introduce you to the Dow Fab 5 Index, which consists of just the 5 highest priced stocks in the Dow Jones Industrial Average, but equally-weighted. Today, this index has Boeing, UnitedHealth, Goldman Sachs, 3M and Home Depot. Price-wise, these 5 stocks alone represent 1/3 of the entire index.

Just to show you how the rest of the market moves with these 5 stocks, I've overlaid the "Dow Fab 5" with the Russell3000 Index, which represents approximately 98% of all investable assets in the U.S. equities market. Here it is going back to the turn of the century:

Click on charts to zoom in

Here is a closer look at this over the past few years. If we see new highs in the Dow Fab 5, it's hard to imagine a scenario where the rest of the market doesn't follow. We're not looking at it as a leading indicator, but more coincident than anything else:

This is the Dow Fab 5 Index on its own. I see prices consolidating last year's monster gains in a sideways range. This is perfectly normal. What stands out to me is that we're consolidating above support near 1200 based on the 423.6% extension of the 2015-2016 correction, not below it. Also, momentum is in a bullish regime, not getting oversold since early 2016. These are all bullish characteristics that suggest a resumption in trend is quickly approaching:

An upside resolution should be expected here, because consolidations historically tend to resolve themselves in the direction of the underlying trend, which in this case is obviously up. Price breaking down below 1200 again in the Dow Fab 5 Index and momentum reaching oversold conditions would likely mean this conclusion is wrong and a more defensive approach is more appropriate. But in my opinion, this is the lower probability outcome. I think we're heading to 1550 in the Dow Fab 5 Index, which points to much higher stock price in the United States this year.

That's how we're positioned.

Tell me what you think!

JC

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