Indicators Show Dumb Money Buying Stock Rally While Others Take Profits

| About: SPDR Dow (DIA)

The excitement over the Dow Jones Industrial Average making new highs within the last couple of days has been electric. Mainstream news outlets have been trumpeting the news of the new record Dow territory.

Chart forDow Jones Industrial Average (^DJI)

Over the past few months retail investors have been adding to their overall allocations in stocks. TD Ameritrade's Investor Movement Index is at the highest point since June 2011.

While the rally in stocks has been spectacular, the importance of the Dow 30 reaching new highs carries very little significance beyond the psychological effect on the retail investor.

The reason that the Dow's new highs are not exactly what they may appear on the surface is due to the fact that the Dow Industrial Average is a price weighted index. This means that the actual price of the stocks of the 30 Dow components are what makes up the index price. This differs from other indexes, such as the S&P 500, which is a capitalization-weighted index. In the case of the S&P 500 Index, the market value of the component companies is what comprises the index's price.

For example:

If we were to replace Exxon (NYSE:XOM) with Google (NASDAQ:GOOG) in the Dow, the Dow Industrial Average would instantly show a huge gain. This is because the stock price of Google is much higher (about $800) than the stock price of Exxon (about $89), even though Exxon is a more valuable company by market cap (about $300 billion), than Google (about $273 billion).

As companies are added or removed from the Dow 30, which they frequently are, it is not hard to see that the value of the index would be affected and would not necessarily be accurate for technical purposes in the same way that a valuation weighted index would be. Over the last six years, by my count, 12 companies have either entered or exited the Dow, these include:

Exiting the Dow 30:

Altria Group (NYSE:MO), Honeywell (NYSE:HON), AIG (NYSE:AIG), Citigroup (NYSE:C), GM (NYSE:GM), Kraft Foods (KRFT)

Entering the Dow 30:

Bank of America (NYSE:BAC), Chevron (NYSE:CVX),, Cisco (NASDAQ:CSCO), Travelers (NYSE:TRV), UnitedHealth Group (NYSE:UNH)

If retail investors are entering the stock market now because they believe a technical barrier has been crossed by virtue of the Dow Industrial Average breaking out to new all-time highs as of two days ago, it is likely that they could be very disappointed. This is due to the fact that many of the flows of broader indicators are not confirming a broad-based stock rally.

The U.S. dollar (DXY) has been gaining ground over the past few months. Somewhere, a significant amount of money is going into cash. This could be indicative of large investors selling into the recent stock rally.

The Treasury Bond Market, which has been considered one of the best safe-haven trades since the financial crisis, is not showing any significant outflows, which would likely be seen if a significant rotation from bonds to stocks were underway.

Conclusion: Given the fact that retail investors are generally the last leg of a bull-market rally, it would appear to be a wise move to sell into this rally and watch for a roll-over to the downside in U.S. stock indexes. At that point, I would look at shorting the U.S. Stock Index's expecting a 10%+ correction, given the length and breadth of this bull-market run.

There is an old saying: "Buy on drums, sell on trumpets."


Disclosure: I am short SPY, IWM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.