Indices Provide Insight Into Market Action, Uncertainty

2022-01-19

This market has been choppy, volatile, and frankly — scary.

However, one major index is showing signs it has potential to be a relative outperformer and help alleviate traders’ fears. The Dow Jones Industrial Average is not as responsive to the interest rate hike announcements by the Federal Reserve and it is important to understand why.

The volatility across the indexes increased when it became official that interest rates would increase from near zero. This is scheduled throughout 2022 through four phases. Typically, when borrowing money becomes more expensive, both businesses and consumers curtail spending. This, in turn, causes earnings to fall and stock prices to drop.

The holdings within the indices affect volatility along with increases or decreases in price. The pressure comes from which stocks are most heavily weighted and the sectors within each index.

The technology-fueled Nasdaq is often considered the most rate-sensitive of the indices. This index holds primarily technology, communications, and consumer discretionary stocks. These tend to be heavily weighted in the Nasdaq.

The S&P 500 is weighted by three sectors – technology, financials, and healthcare. Sector holdings tend to be household company names or “darling” stocks regularly touted by the media.

Keep in mind, between all the indexes as the market moves, the holdings in the indices adjust across the board.

The Dow still operates according to classic “Dow theory,” and this tends to cause the index to move slightly differently. Some early theories are not applicable anymore as the weighting attributed to Charles Dow’s era has changed. Yet, the number-one weighted sector in the Dow is still financials, followed by technology and healthcare.

The holdings in the Dow are arguably better suited for today’s market environment and have the potential to lead to potential trading opportunities. Financial markets (heavily weighted in the Dow) do well when the Central Bank increases interest rates. And, when investing dollars move out of other sectors and into areas such as financials and healthcare stocks, momentum in those sectors benefits the Dow.

By taking time to review the weighting of the sectors within the indices, Simpler’s traders can better understand action that may lie ahead for the indices. This insight helps alleviate fears in an uncertain market.