Dow 30 index is overvalued as of Dec 7, 2020

The Dow 30 index is a general index that measure the sentiment of the US equity market as well as investor in long run since it consist of the main 30 companies that affect the market and the economy in general. This index shows if the market is going in uptrend, downtrend or sideways. Because of that I used this index as a base for my analysis and I used all companies inside this index in order to come up with my index which shows the real value of Dow 30 index. My index which I am going to call it Sam 30 index is based in Dow 30 index as benchmark to all investors and traders alike to see if the Dow 30 index is an overvalued or undervalued or has fair value.

I am not going to describe the process that I did to come up with Sam 30 index, instead of that I am going to discuses how does Sam 30 index can be used in conjunction with the Dow 30 index in order to allow investors and traders see if there is an opportunity to go long or short or even to step aside and do nothing.

Let us assume that the Dow 30 is 30,000 points and Sam 30 is 23,400 that means the Dow is greater than Sam 30 with more than 6600 points, which means the Dow 30 is overvalued and investors should not invest in the market , and traders on the other hand should apply their technical analysis to see an opportunity for shorting any overvalued stock in this market. The same is true if the Dow 30 was 23,400 points and Sam 30 was about 35,000 that means the market is undervalued and investors and traders should look for an opportunity to go long with any undervalued stocks.

Sam 30 is not day by day index, instead is an index where its value updated whenever new earning report released by the companies that built the Dow 30 index. Once the earning report released for any company of those 30 companies that listed in Dow 30, Sam 30 index will be updated to its new value in the next day.

As of December 7, 2020 the Sam 30 value is 22,495.92, that means, when we do our analysis that described above, the market is overvalued

Dow 30Sam 30
30,218.2622,495.92
Comparison between Dow 30 and Sam 30

As you can see above the Dow 30 is greater than Sam 30 with more than 7,700 points which means that the market is overvalued and I suggested that investors to step back and do nothing while traders can short any overvalued company based in their technical analysis.

Market Sentiment: How can be measured?

A lot of traders are using indexes or at least the major one to see if the market is going up or down or does not move in either way as sideways movement. This a very helpful technique that used by traders and investors to see if the market is willing to pay some profit in either way by going long or short, or if the market is not moving at all which can be better to stay out of it.

Many traders and investors alike using S&P 500 as a gauge for market sentiment to see if the market is about to have a new breakout move or continue its original one before they trade or invest in any stocks. This approach is more helpful for traders and investors because it will prevent them to invest or trade in phases where market is not going any way, or even worst when it move or start move in downtrend.

But the question to ask here, is measuring market sentiments by using S&P 500 is a good approach or there is another index that is better in measuring the market sentiment rather than S&P 500.

Before answering the above question let us understand what is S&P 500 and how can be calculated?

S&P 500 is simply an weighted average for 500 companies. These companies are the most largest companies in U.S economy. Some of those companies have higher weight than others based in their size and how big financially are such as Apple, Microsoft. As the name imply there are 500 companies in this average. Some of these companies are consider leaders of U.S Stock market, such as Apple, Microsoft, Google, Amazon, while there are so many companies that included in this index are considered a lager companies.

From statistic point of view, when the sample number is increased the average for that sample is almost coming to normal and anomaly will be disregard. To make this simple, when there is a bad companies in that average are mixed with good companies, the value of those bad companies will be disregard since their value will not affect the average specially if those companies are smaller in weight than those good one. That was the reason that S&P 500 index broke the top that made in Feb 2020 in beginning of this year, even if there were so many companies are reporting bad earning report.

S&P 500 Break Resistance

But what if the sample size is been minimized to 200 or 100 or 50 or may be 30 such as Dow 30 index. What will happen in this case?. The answer is obvious, the average will be more sensitive. That means when there is an anomaly appear, the average will effect immediately either if that anomaly was good or bad. And here comes the important to take Dow 30 index which is known as Dow jones industrial average as measurement of market sentiment.

Dow 30 consist of the biggest companies of all sectors of the stock market. It vary from technology companies to petroleum companies as well as banks and pharmaceutical companies. The variation of these biggest companies and the limitation of this average to consider only 30 biggest companies in U.S economy which make this average a unique market sentiment specially when investors or traders want to know if it is a bull or bear market.

For example, in 2020 where coronavirus pandemic started the market wiped all its profit since 2016 in just five weeks. All other indexes such as S&P 500, NASDAQ and other European indices have been recovered from that drop except the Dow 30 which still failed to reached the top that made in Feb 2020 as shown in the pictures below:

S&P 500 break the top reached in Feb 2020
NASDAQ 100 Break the top made in Feb 2020
Dow 30 failed to break the top made in Feb 2020

As we can see from the above charts there was an anomaly. These indices should be aligned with each other and broke the top made in Feb 2020 in order to prove the sell off that started in Feb 2020 has been recovered, but since Dow 30 still did not break that resistance made in Feb 2020, it will be hard to tell if the market has been recovered from coronavirus effect or not.

Alignment for all indices is important in order for traders and investors to tell if they are in bull/bear market, and Dow 30 index shows through years if the market is in uptrend, downtrend or sideways. That does not neglect the importance of S&P 500, or NASDAQ composite, they are both good tools to measure the market sentiment, but when it come to overall result, I believe Dow 30 has the final word to decide if the market is about to move either way.