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Since January 3, 2022, when the last stock market correction started, the Dow Jones Industrial Average (DJI) has outperformed all three other major equity indexes on a total return basis.
Performance of 4 total return stock market indexes (Price Action Lab Blog – Norgate Data)
Despite a gain of 55.1% for the NASDAQ-100 total return last year, the Dow is still ahead with a gain of 11.2% versus 10.4% for the tech stocks since the start of 2022, on a total return basis. The S&P 500 total return is 8.7%, and small caps are in the red with a loss of 6.6% and down 14% from all-time highs.
The Dow has maintained its relevance amid higher stock market realized volatility due to high-quality large caps such as Merck (MRK) and Travelers Companies (TRV), among others. These two stocks have been the most overbought since the 1970s.
Merck
Daily chart of MRK (Price Action Lab Blog – Norgate Data)
The stock of Merck has been overbought for 33 days as of the close of Friday, February 16, 2024, with an RSI (14) above 70. This is by far the longest period this stock has remained overbought since 1975. The drivers of the extended overbought conditions were better-than-expected earnings-analysts anticipated a loss-and announcements of several acquisitions to strengthen the position of the company in the pharma sector. Note that the average time that this stock has remained overbought has been about four days historically, and a 33-day overbought period is an extreme outlier.
Travelers Companies
Daily chart of TRV (Price Action Lab Blog – Norgate Data)
The stock of Travelers Companies has been overbought for 36 days as of the close of Friday, February 16, 2024, with an RSI (14) above 70. This is the longest period this stock has remained overbought since 1975. The drivers of the extended overbought conditions were record earnings, boosted by a significant rise in insurance premiums.
Note that the average time that this stock has remained overbought has been about six days historically, and a 36-day overbought period is an extreme outlier.
Stocks can stay overbought for longer than shorts can remain solvent
Extended overbought conditions are one of the reasons that make shorting the stock market unprofitable in the long term. In reality, technical overbought conditions arise due to strong momentum in a bullish market. In the case of the Dow, on January 2 of this year, this index completed a long streak of 27 days in overbought territory, which was the second longest since 1945. The longest such period was 28 days, which came to an end on November 8, 2017, and then there was a melt up and a gain of about 12%.
Daily chart of Dow Jones Industrial Average (Price Action Lab Blog – Norgate Data)
Overbought conditions can vanish, but momentum can stay strong
It only takes a few days of a small decline or sideways consolidation for overbought conditions to vanish, but momentum can remain strong. Therefore, extended overbought conditions are not a robust indicator of a major reversal. It is also not necessary to have overbought conditions for a market top.
Conclusion
The Dow is still relevant because it includes high-quality large caps with solid earnings and growth potential. The Dow has outperformed both the NASDAQ-100 and the S&P 500 index since 2022. The outlier overbought conditions in the stocks of Merck and Travelers Companies are a reflection of strength and strong momentum not seen in many decades. This momentum could continue if inflation is kept under control and the Fed delivers rate cuts this year.
