Dow, Russell 2000 Market Divergence -- Warning or Opportunity?

NEW YORK (TheStreet) -- Anyone watching the markets the past few days feel like they are watching a yo-yo competition. Up one day, down the next, only to reverse even higher the next has investors dizzy when contemplating their next move.

Prior to last week's second consecutive small loss, the S&P 500 (SPY) had been oscillating up and down for the past 10 weeks. In spite of all that daily and weekly inverse action, both the Dow Jones Industrial Average (DIA) and the S&P 500 are still within 1.2% of their all-time highs, which were set just last week! So what's the problem? Everything must be great.

Unfortunately, any time there is back-and-forth vacillation in price movement, it demonstrates confusion within the investment community. In technical parlance, it is called "churning." Churning action near the top price levels for a stock or a market index isn't necessarily a bad thing. However, investors need to keep a close watch for a potentially bad outcome should prices break down.

Let's use the SPDR Dow Jones ETF (DIA) as a proxy. It closed Thursday at $165.18, down 0.18% year to date.

A close below $158.70 would be the signal of a breakdown, and most likely more selling and lower prices will follow. That level breaches both the 200 Day Moving Average and the lowest price traded over the last 14 weeks. The Dow ETF has only traded higher than the December 31, 2013 all-time high of $165.51 on nine days this year. Year to date there has been no gain for DIA, and it's almost Memorial Day!

When stocks or indices consistently try and fail to cross resistance -- in this case the December high -- most times at least a moderate pullback ensues before another attempt is made. It feels like that may be happen sometime soon for several reasons.

A quick look at last year's leading index, the Russell 2000, is a cause for consternation. The price chart of the iShares Russell 2000 ETF (IWM) demonstrates that last year's uptrend has been broken. It appears that it is going to be in full correction mode soon, which is defined as a loss of more than 10% from its previous high. Currently the Russell 2000 ETF is 9% lower than its March 4 level.

Last year the Russell 2000 ETF returned 38.9%, which was significantly more than the Dow ETF's impressive 29.4%. The Russell 2000 ETF was clearly the market leader. So far this year, the two major indices have taken divergent paths, as DIA is flat on the year, while IWM is off 5%. It can't be stated with any clarity yet if this is an opportunity, due to leadership rotation to large-cap stocks or a warning that the small-cap index is still leading and the Dow index has more catching up on the downside to come.

The economic news continues to come in mixed. Jobs are being created, but more people are leaving the workforce than getting new jobs. First quarter GDP was horrible, but many blame the weather. Mixed signs of slowing growth continue. Time will tell.

For investors who want to continue to participate in the market: be sure to recognize that large-cap stocks are the place to be right now. Those big company names are well represented in DIA.

We continue to hope that the stock market moves ever higher, but we do have an exit strategy in place should DIA fall below $158.70. That's a low risk trade for those sitting on the sidelines today!

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-- By Jerry Slusiewicz, follow on Twitter , Facebook and Linkedin .

At the time of publication, the author held DIA but held no positions in any of the other stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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