History suggests stocks are due for a pause

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The Dow Jones Industrial Average (^DJI), Nasdaq 100 (^NDX), and S&P 500 (^GSPC) all notched record highs on Wednesday. The latter, the world’s benchmark stock index, also came tantalizingly close to hitting the big, psychological 5,000 level for the first time.

Meanwhile, stocks are now in one of the seasonally weakest months of the year, with an even weaker month ahead often seen in election years. We’re also sitting on a monster three-month rally that history suggests might take a few weeks to digest.

While no one is suggesting investors should tear off their “S&P 5,000” hats and short Nvidia (NVDA), it’s a good time to take stock of what’s been working this year and of some of the increasing divergences that might need correcting.

Classic Dow Theory posits that the Dow Jones Industrial Average and the Dow Jones Transportation Average (^DJT) should agree with each other. In general, there should be broad, directional agreement between the companies that make the stuff and the companies that ship the stuff.

Recently, the industrials have been hitting record highs while the transports have been struggling to break through prior resistance. While this could be resolved by the transports surging higher, seasonals suggest that industrials might “catch down” to the transports.

Then there are the megacaps. Whether it’s the Mag 7, Mag 6, or Mag 4, the subject of market concentration has been talked to death as narrow leadership has gripped the minds of stock market bulls and bears alike.

We can see this in the ratio between two different ways of calculating the S&P 500 — by the usual method of market capitalization, and also by equal weight, wherein each stock has an equivalent weighting in the index.

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The above chart shows that large caps dominated early in the pandemic in 2020, but were taking…