The Dow Has Trailed the Nasdaq for Most of a Year. What Does It Mean for the Stock Market?

The excitement surrounding the Dow Jones Industrial Average surpassing 40,000 for the first time now feels like a distant memory. Since reaching this milestone, the blue-chip index has dropped over 3%, experiencing its steepest two-week decline in over a month, while the broader market continues to climb.

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Although the Dow clung to a modest 2% gain in May, it significantly lagged behind the tech-heavy Nasdaq Composite by the widest margin since May 2023. It also underperformed the large-cap S&P 500 by the largest margin in three months, as reported by Dow Jones Market Data.

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In May, the Nasdaq surged 6.9%, marking its best month since November, while the S&P 500 rose 4.8%, its biggest monthly gain since February, according to Dow Jones Market Data.

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Market analysts caution against using the Dow’s drop from its record high as the sole indicator of stock market performance in May. Despite a shift from some mega-cap tech firms to previously overlooked sectors like utilities and small-cap stocks, this may not be the type of rotation investors prefer, analysts noted.

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The recent downturn in the Dow has been driven by several factors, including disappointing quarterly earnings reports from Salesforce Inc. (CRM), which saw its shares plummet nearly 20% on Thursday, marking its worst day in two decades. This slump alone shaved off about 350 points from the Dow on Thursday, according to Dow Jones Market Data.

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Additionally, a combination of robust U.S. economic data and weak government debt auctions has driven longer-term Treasury yields higher. This has added downward pressure on the stock market amid concerns that the Federal Reserve may not be able to lower interest rates later this year despite declining inflation.

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James Ragan, director of wealth management research at D.A. Davidson, explained, “Ever since the Dow hit that 40,000 all-time high, it coincided with the market becoming more narrow, led by tech stocks for the last few weeks.” He added that the Dow has an 18% weighting in technology stocks, compared to over 30% for the S&P 500.

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One reason for the Dow's significant downturn compared to other major indexes is its nature as a price-weighted index. Unlike the S&P 500, which is market cap-weighted and gives greater influence to larger companies, the Dow considers only the share prices of its components, making it more sensitive to price movements.

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UnitedHealth Group (UNH), with a stock price above $490 per share and a market valuation of $443 billion, holds the largest position in the Dow at 8.3%. Meanwhile, Amazon.com (AMZN), trading at around $180 per share with a market cap nearing $1.9 trillion, represents only 3% of the Dow’s weighting, according to FactSet data.

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Nvidia Corp. (NVDA), which gained 27% in May and finished above $1,096 per share on Friday, was a top performer in the S&P 500 and the Nasdaq, but it is not a Dow component.

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As JJ Kinahan, CEO of IG North America and president of the brokerage tastytrade, noted, any stock in the Dow can have a significant impact on the average. He added that while the Dow is a good guide for average investors, the S&P 500 and Nasdaq are better reflections of the stock market and U.S. economy due to the larger number of stocks they track.

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The recent stock rally has expanded into utilities and small-cap stocks. Utility stocks, particularly the Utilities Select Sector SPDR Fund, outperformed the market, surging nearly 9% in May, the largest monthly gain since March 2022, according to FactSet data.

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Small-cap stocks, tracked by the Russell 2000 index, outpaced the S&P 500 and Dow with a 4.9% monthly gain, marking their best month since February, according to FactSet data.

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However, consumer-discretionary stocks lagged, with the S&P 500 energy and consumer-discretionary sectors underperforming, showing minor gains or declines. Retailers and restaurant chains like McDonald’s Corp. (MCD) and Target Corp. (TGT) faced challenges in May, reflecting consumer adjustments to higher prices.

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Despite the outperformance of some previously lagging sectors, James Ragan of D.A. Davidson cautioned that this doesn’t necessarily indicate an improvement in overall market breadth. He observed that tech-centric companies have driven recent gains, and there’s a need for more sustained broadening.

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In May, both the Technology Select Sector SPDR Fund and Communication Services Select Sector SPDR Fund achieved their best monthly performances since November, according to Dow Jones Market Data.

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U.S. stocks finished mostly higher on Friday, with the Dow industrials up 1.5%, the S&P 500 rising 0.8%, and the Nasdaq nearly flat, following the April personal-consumption expenditures index inflation gauge meeting expectations, according to FactSet data.

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