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Nasdaq/Dow Divergence: What Does it Mean?

Written by Briton Ryle
Posted August 21, 2018 at 8:00PM

A Wealth Daily reader shared this chart from Stansberry on Twitter and asked for thoughts on what it means:

What do you think this divergence means?

I think it's a great question. It prompts a lot of other questions. So let's dig in: What does this divergence mean? 

The first observation is that stocks in general have done great over the last 12 months. This chart shows the Dow Industrials up 18% and the Nasdaq up 24%. Those gains are way above historical averages of around 8% annually.

I reference one of my favorite pithy sayings when answering the question, "What does divergence mean?"

The pithy saying is, "When you hear hoofbeats, think horses, not zebras." It's a version of Occam's razor, the simple explanation is likely correct. My simple answer for why the Nasdaq has done so much better than the Dow is that Amazon (NASDAQ: AMZN) and Google (NASDAQ: GOOG) are not included in the Dow Industrials.

If Amazon ($1,895 a share) and Google ($1,214 a share) were in the Dow, the old-school index would be trouncing the Nasdaq. Seriously, the Dow's gains would be at least double what they are now.

Why would just two stocks make such a difference? Because the Dow is price-weighted instead of market cap-weighted. That means the dollar amount of the stock price counts for more than the actual value of the company. In other words, if Amazon were in the Dow, it would be valued at 9x Apple, even though Apple is a bigger company. Google would have nearly 6x the influence in the Dow that Apple does. 

I think it's pretty safe to say that neither Google nor Amazon is more important or influential for the U.S. economy than Apple. Let's say they are about the same. 

When Charles Dow first created his Dow Industrials index back in 18-long-time-ago, the point was to offer up a snapshot of how the U.S. economy was doing. Back then the U.S. was mainly an industrial economy. And the original Dow Index had just 12 companies: American Cotton Oil, American Sugar, American Tobacco, Chicago Gas, Distilling & Cattle Feeding, General Electric, Laclede Gas, National Lead, North American, Tennessee Coal and Iron, U.S. Leather, and U.S. Rubber.

Needless to say, the U.S. economy has changed a lot since then. So has the Dow. Now we've got Dow companies like Intel and Apple. Goldman Sachs and JP Morgan. Boeing and Home Depot. 

Why Be Smart? 

Now, I suspect the original question here is supposed to suggest that we are in a tech bubble, a la 1999–2000. I mean, Apple just makes phones. Big whoop. Won't fickle consumers abandon iPhones the minute something better comes out? In terms of value to the global economy, shouldn't Exxon Mobil (NYSE: XOM) still be vying with Apple for the most valuable company on the planet like it was five years ago? 

Um, not if you ask my kids. I got my daughter a 2001 Audi A4 for her 18th birthday. My first car was a beater, a 1975 Chevy Vega. I figured hers should be, too. She didn't want it. Didn't want the hassle of a car when she leaves for college this Saturday (ohmygodohmygodohmygod). Can you imagine? 

When I was young, a car was my interface for the world. It was my independence. It was the means by which I went places and met people. That's not how it is anymore. You can lament "these kids today" all you want. It's not going to help your shares of American Lead or U.S. Rubber. 

In terms of growth, relevance for the future, I'll take Apple over Exxon every day of the week. 

Now, I know the bullish case I am making for Apple/tech/Nasdaq over Exxon/real-world/Dow doesn't sound terribly smart. No one will ever say "cuz, my daughter" is a profoundly insightful investing strategy. But here's the thing: Bullish arguments rarely sound as smart as bearish ones. 

I don't ever get to use words like divergence, mean-reversion, parabolic, or inflation-adjusted. I mean, if those multisyllabic marvels would make me money, I might give it a shot (after I looked up the definitions). But I've found that words like "that's cool" and "gee whiz" make me a lot more money.

Amazon, Apple, and Google

OK, I will admit it. As Wealth Advisory readers well know, my analysis goes a bit deeper than "cuz, my daughter." I actually don't buy stocks because of their cool factor. (I also don't want to minimize the potential negatives of a full-blown trade war here, of which I'm growing increasingly worried.)

My point is simply horses and zebras. I'm not gonna bend over backwards to find out why everything sucks and it's all gonna come crashing down. Even if those arguments carry more emotional weight.

Philosophical tangent: I think the reason bearish arguments resonate so much has to do with Kierkegaardian existentialism. There comes a point in our lives when we realize it's all bullshit. Some people simply stop at Nietzsche's nothing matters. From there it's easy to say the U.S. dollar will be worthless, buy gold. But I would say let's take Kierkegaard to his full conclusion: the only meaning in life is the meaning we give it. I am completely fine with U.S. dollars being worth exactly what humans think they're worth. Apple, too. 

So, take a minute to ponder Amazon, Google, and Apple. Google is the translator of the internet. As much as I am frustrated by the tunnel vision of Google search, I have to admit it killed Viagra spam and makes the internet useful. 95% of internet search goes through Google. And a fair amount of that 95% leads us to Amazon, where we buy something.

In addition, the servers at Amazon Web Services (along with Microsoft's Azure) are where much of the internet lives. And then Apple has the devices through which we connect with Amazon and Google. Pretty simple.

One more thing: I was talking with my good friend Christian DeHaemer (affectionately known as The Hammer) the other day. He mentioned some analyst who used the phrase "pioneers get slaughtered." That's fantastic.

The 1999–2000 Nasdaq bubble was all about pioneers getting slaughtered. I've written about the company I think was the poster child for the internet bubble in Wealth Daily before. It's not who you think, and it's a great story.

I don't think today's Nasdaq looks anything like the 2000 Nasdaq. With a few exceptions, today's tech stocks aren't pioneers. They are mission-critical chip companies, data center companies, data security companies, and internet services companies. 

The biggest company in the world pays a dividend and trades with a forward price-to-earnings (P/E) ratio just under 16. I'd have to get awfully smart to see that as a bubble.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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