Markets Can Keep Rallying After This Rare Divergence

Stocks are soaring relentlessly in 2024...

The artificial-intelligence boom has sparked a lot of excitement. And it's driving earnings growth for the largest stocks in the U.S.

So the bull market that took off in 2023 has charged higher... with an impressive double-digit rise in the first half of this year. But not all stocks are moving up.

You see, a rare divergence is setting up in the market. But while it's unusual, it won't cause a collapse.

Instead, stocks should keep rising. And as I'll explain, a certain group is set to lead in the months to come.

When I say "stocks," you might not know exactly what I mean. After all, the U.S. market has three major indexes... the S&P 500, the Nasdaq Composite, and the Dow Jones Industrial Average.

Most of the time, they track each other closely. They're all broad, diversified indexes. And because they all have such wide coverage across sectors, they tend to go up and down together over time.

That hasn't been the case this year, though. Specifically, the Dow Jones has lagged behind in a big way. It's only up 6% in 2024, while the S&P 500 and the Nasdaq are up 18% and 23%, respectively. Take a look...

It hasn't been a bad year for the Dow. The Dow gained 6% in the first half of 2024... which is above the long-term average. But it's a far cry from the larger returns in the S&P 500 and the Nasdaq.

To see what this might mean going forward, I compared historical six-month returns of the Dow Jones and the S&P 500... and what would happen if you owned each of them after similar periods.

Specifically, in the first six months of 2024, the S&P 500 outperformed by nearly 11 percentage points. That has almost never happened in the past...

We've only seen nine other cases near that difference since 1950. Here's what the S&P 500 has done after similar setups...

Buying the S&P 500 after six months of crushing the Dow is a fine strategy. It has led to gains of 9.7% over the next year... better than buying and holding the S&P 500 in a typical one-year period.

You can do better, though. You just need to buy the underperforming index instead. Here's what the Dow did after the same setups...

The Dow Jones has a history of slightly lower buy-and-hold returns than the S&P 500. But after these situations, it leads to larger future gains...

Similar setups led to 8% gains in six months and 11.6% gains over the next year. So this divergence isn't a warning sign. It's a signal to stay long... but to do it by owning the Dow instead of the S&P 500.

That said, you shouldn't change your entire investment strategy based on this idea. If you own the S&P 500, that's OK. It's not worth selling everything and swapping indexes today.

The more important point is, this signal isn't a warning of pain to come...

Stocks rarely diverge like they're doing today – but it won't kill the rally. Instead, this bull market should continue in the months to come.

Good investing,

Brett Eversole

Further Reading

"We're smack-dab in the middle of a secular bull market," Brett writes. So if you're waiting for lower prices to buy into the rally, you'll likely be waiting a while. Here's why now is the best time to be invested... Read more here.

Despite the new market highs, folks are still fearful today. Many investors are piling up cash as a result. But this is a positive sign for the bull run. It tells us we're nowhere near a top... Learn more here.