INVESTORS SWITCH TO LARGE CAPS -- THAT EXPLAINS WHY THE DOW HAS BEEN THE FIRST INDEX TO HIT A NEW HIGH -- RECENT DOW BREAKOUTS INCLUDE DISNEY, UNITED TECHNOLOGIES, AND WAL-MART

SHIFT TOWARD LARGE STOCKS... One of the more obvious discrepancies of late has been between the performance of the Dow Industrials and the Russell 2000 Small Cap Index. While the Dow (blue line) has been the first of the major stock indexes to hit a new recovery high, the RUT (black line) has barely recovered half of its October drop. There are a couple of possible conclusions that can be drawn from that discrepancy. One is that investors are turning more defensive. In the early stages of a market upturn, small caps usually lead the way. In the latter stages of an upturn, investors usually rotate toward more stable and larger blue chips. Chart 2 plots a relative strength ratio of the small cap index (blue line) divided by the Dow (flat black line) over the last year. The RUT/Dow ratio bottomed last November and turned up in March as the market bottomed. In other words, small caps led the market higher until mid-September. The falling ratio since then shows small cap underperformance (or large cap outperformance). A more subtle message is being given by the fact that the Dow has been the first index to hit a new recovery high.

Chart 1

Chart 2

DOW STARTS TO OUTPERFORM S&P 500 ... A more subtle rotation is shown in Chart 3. That charts plots a relative strength ratio of the Dow Industrials (blue line) to the S&P 500 (flat black line) over the last year. The ratio shows how the Dow is doing relative to the market as a whole (S&P 500). The chart shows that the Dow has started to outperform the S&P 500 for the first time since the start of the year. The last time the Dow/S&P 500 ratio turned up was lthe summer of 2008. That doesn't mean that the market is turning down. It seems to mean that investors are becoming a lot more selective in what they're buying and are starting to favor safer stocks which are usually bigger ones. It just so happens that the biggest blue chips are located in the Dow. That may also explain recent buying of more defensive categories like consumer staples and healthcare . The moral of this message is simply that investors are now starting to favor the largest stocks like those in the Dow. Part of the reason is that they're perceived to be safer and are usually the last to peak. Large multinational stocks also tend to do better when the U.S. Dollar is weak.

Chart 3

RECENT DOW BREAKOUTS ... Three of this week's upside Dow breakouts are shown below. Disney (Chart 4) hit a new 52-week high today. So did United Technologies (Chart 5). Both of their rising relative strength lines are measured against the Dow. Chart 6 shows Wal-Mart breaking out to an eight-month high. The big retailer still needs to clear its March high near 54 to turn its major trend higher. Its relative strength line shows that WMT has been a Dow underachieverall year and is just starting to do better.

Chart 4

Chart 5

Chart 6