Market Trek: We’re Watching This Stock Market Divergence, and So Should You

Hey guys, Brian here. Hope your week is going great.

Little market history lesson today. February 1966: that month marked the orthodox end of Cycle Wave 3 in the Dow. There was a divergence back then that helped analysts navigate that bear market.

A similar divergence just popped up again today, and not many people know about it. So stay with me.

All right guys, welcome back. Before we look at these charts, let me just show you where I was last month.

This is the Nikko Toshogu Shrine. We’re in Nikko. This is about a two-hour train ride from Tokyo. The interesting thing, one interesting things, about Nikko is that a lot of Japanese firms hold their high level meetings and retreats here. It’s a really peaceful place. Thought to be good for strategic planning, decision making, team building.

There’s also cool story about a secret hidden treasure somewhere in the shrine, gold and gems, samurai artifacts from the Edo Period. Treasure hunters, I’m told, have scoured the place, and the treasure is still out there. I certainly didn’t find it. So, best of luck to anyone else who visits. I really enjoyed Nikko. The whole area is just beautiful.

But, let’s get back to this market model from ’66. All right, these graphs come from the latest issue of Global Market Perspective. (Subscription links below.)

Top graph here is the nominal Dow. This is the Dow we see every day. Bottom graph is the Dow divided by the Producer Price Index. We call it the Inflation-Adjusted Dow. It’s essentially what stocks would look like in terms of the things that we all buy.

These two peaks here are important. This is February 1966, end of cycle wave three. Here, the peak in the Dow coincided with a peak in the Inflation-Adjusted Dow.

This is December ’68. Nominal prices almost match that prior peak. Inflation-adjusted prices are lagging here. This non-conformation leads to declines of 36%.

And ultimately, if we extended this chart out through the early ’70s, the Dow rallied, but then it declined another 45% into December ’74.

Let’s look at the same indexes today. Dow rallies to a new high on January 2. Inflation-Adjusted Index doesn’t make it, right? And neither do a lot of the broader indexes.

There has been no new high in the Wilshire 5000, no new high in the New York Stock Exchange composite, no new high in the Russell 2000 or the Value Line Composite.

So, just as in ’68, we think the enthusiasm has pushed a select few averages to new highs, but many more indexes are weak. We view this as a fractured market. It’s an unhealthy market, and ultimately, it’s a market that is vulnerable to significant decline.

So, let me know what you think in the comments. Again, subscription links below, if you like this kind of analysis, if you’d like to subscribe to our newsletters. And thanks for watching.