Dow trails Nasdaq by most in a year. What it means for the stock market.

By Isabel Wang

Outperformance of previous laggards doesn't confirm improving stock-market breadth, say analysts

The thrill of the Dow Jones Industrial Average breaking 40,000 for the first time in history feels like a distant memory. The blue-chip index has since plummeted over 3% to suffer its sharpest two-week slide in over a month, while the rest of the market has stayed on its upward trajectory.

Despite clinging to a roughly 2% gain in May, the 30-stock index DJIA still lagged behind the tech-heavy Nasdaq Composite COMP by the widest margin since May 2023. It also underperformed the large-cap benchmark S&P 500 SPX by the biggest margin in three months, according to Dow Jones Market Data.

The Nasdaq was up 6.9% in May, notching its best month since November, while the S&P 500 advanced 4.8% to record its biggest monthly gain since February, according to Dow Jones Market Data.

Investors should caution against relying solely on the Dow's decline from its record high to gauge the stock-market performance in May, according to market analysts. While some mega-cap tech firms have given way to previously overlooked sectors like utilities and small-cap stocks, it may not be the rotation investors would like to see, said the analysts.

See: Stock market rally puts S&P 500 on track for best May performance since 2009

The downturn in the Dow industrials over the past two weeks has been fueled by a range of factors, including soft quarterly earnings reports from Salesforce Inc. (CRM), which sent its shares sliding nearly 20% on Thursday to suffer its worst day in two decades. The slump also shaved off around 350 points from the blue-chip index on Thursday alone, according to Dow Jones Market Data.

Meanwhile, a batch of robust U.S. economic data and weak government debt auctions have propelled the longer-term Treasury yields higher BX:TMUBMUSD10Y, adding to the downward pressure on the stock market amid concerns that the Federal Reserve may not be able to lower interest rates later this year despite the fall in inflation.

"Ever since the Dow hit that 40,000 all-time high, it coincided right after when the market overall became a little more narrow with the tech stocks leading [the rally] for the last couple of weeks," said James Ragan, director of wealth management research at D.A. Davidson. "My calculation is that the Dow has about 18% weighting in technology stocks, whereas the S&P 500 has over 30%."

To be sure, one reason the Dow experienced a significant downturn while other major stock indexes remained near their record levels is due to its nature as a price-weighted index. Unlike the S&P 500, which is a market cap-weighted index and gives greater influence to larger companies with higher market capitalization, the 30-stock Dow solely considers the share prices of its component, making it particularly sensitive to price movements.

UnitedHealth Group (UNH), with a stock price above $490 per share and a market valuation of $443 billion as of Friday afternoon, holds the largest position of 8.3% in the blue-chip index. Meanwhile, Amazon.com (AMZN), trading at around $180 a share with a market cap approaching $1.9 trillion, represents only 3% of the index's overall weighting, according to FactSet data.

Nvidia Corp. (NVDA), which saw a 27% monthly gain and finished above $1,096 per share on Friday, was one of the top performers in the S&P 500 and the Nasdaq for the month, but it is not a Dow component.

As a result, any stock in the Dow could have a much greater chance to influence the average, said JJ Kinahan, chief executive of IG North America and president of the brokerage tastytrade.

He added that Dow Jones is "a great guide" for an average investor, but the S&P 500 and the Nasdaq are "probably a better reflection" of the stock market and the U.S. economy because of the number of stocks they track.

Stock rally expands into utilities and small-caps

While some of the megacap technology firms like Nvidia maintained their leading roles in the rally, others have begun ceding space to previously overlooked market contenders like utilities and small-cap stocks. This shift might be indicative of investors rotating their positions and easing up on some of the lagging sectors, Kinahan told MarketWatch via phone on Friday.

Utility stocks in May left the rest of the market in the dust. The Utilities Select Sector SPDR Fund XLU emerged as the top performer among the 11 SPDR ETFs tracking the S&P 500 sectors. It surged nearly 9% this month, logging its largest monthly gain since March 2022, according to FactSet data.

The Fed's interest rate cut outlook, coupled with rising demand for electricity driven by artificial intelligence chips and software, has made the traditional defensive sector of the market increasingly appealing.

See: The surprising reason why utilities stocks have suddenly transformed into the hottest sector on Wall Street

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

Consumer-discretionary stocks lag

In terms of what trailed the broader market in May, the S&P 500 energy XLE and consumer-discretionary sectors XLY were two of the worst-performing corners of the index, with their ETFs down 0.3% and eking out a gain of 0.2%, respectively, according to FactSet data.

Some of the biggest retailers and restaurant chains tumbled in May, with shares of McDonald's Corp. (MCD) and Target Corp. (TGT) off 5.2% and 3%, respectively, amid weakness in sales of discretionary items as consumers try to adjust to a new normal of much higher prices.

See: How Big Macs and Chick-fil-A sandwiches became America's hot new status symbols

"The retailers are a wild picture in terms of how well the companies are performing, so there's been a lot of volatility," Kinahan said. "You have T.J. Maxx [earnings] (TJX), which has been doing alright, but you have McDonald's, which has been all over the place with the pricing wars, and you have Tesla Inc. (TSLA) in there, which is an element of volatility to that sector."

Why market breadth may not improve

However, the outperformance of some of the previous laggards doesn't necessarily confirm an improvement in overall stock-market breadth, said Ragan of D.A. Davidson.

The information-technology sector XX:SP500.45 within the S&P 500 was up nearly 12% since logging one of its 2024 lows on April 19, while the index overall was up only 5% over the same period, according to FactSet data.

"We've been concerned. It seemed like over the last six-week period the gains have been much more narrow in these tech-centric companies, and we want to see more broadening that sustains...," Ragan told MarketWatch in a phone interview. "May has ended with more concentration [in tech] than we saw in the early part of the month."

Both the Technology Select Sector SPDR Fund XLK and Communication Services Select Sector SPDR Fund XLC scored their best monthly performance since November, according to Dow Jones Market Data.

U.S. stocks finished mostly higher on Friday after the April personal-consumption expenditures index inflation gauge reading came in around expectations. The Dow industrials advanced 1.5% on Friday, while the S&P 500 was up 0.8% and the Nasdaq finished nearly flat, according to FactSet data.

-Isabel Wang

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06-01-24 0508ET

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