Yesterday, the Dow Jones Industrial Average gained 0.17% but the S&P 500 fell by about the same amount. Divergences in the returns of these two indexes occur about 10% of the time in daily, weekly and monthly timeframes and they are mostly the result of alternating risk-on/risk-off.
Below is a daily chart of Dow-30, S&P 500 since 1985 and the sum of their daily signed returns.
A histogram of the sum of the signed returns of the two indexes is shown in the bottom pane when their product is negative. There are 8003 daily returns in the chart and 872, or about 10.9%, diverge in sign.
During the dot com crash there was divergence clustering along the downtrend but a similar phenomenon did not occur during the financial crisis downtrend, probably due to shorter duration. It does not appear that these divergences have any value for forecasting future returns, although a more rigorous study is needed here.
It is interesting that the frequency of divergence remains about 10% in the weekly and monthly timeframes, as shown in the charts blow (click images to enlarge.)
The divergences in signed returns of Dow-30 and S&P 500 often occurs when there is a switch from risk-on to risk-off or the other way around. For example, when investors move to safer assets ,larger divergences can occur, as it was the case during the dot com crash. However, at this point there is no evidence there is a flight to lower volatility large caps and risk is still on.
If you have any questions or comments, happy to connect on Twitter: @mikeharrisNY
Charting and backtesting program: Amibroker
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