The Dow Jones Index and its top indices, like the DIA, soared to a record high last week as investors reflected on the decision by the Federal Reserve to slash interest rates for the first time this year. It jumped to a high of $46,238, up by over 26% from its lowest level this year. Here are the top risks that may drag it lower in the near term.
Dow Jones Index has technical risks
The daily timeframe shows that the Dow Jones has been in a strong rally in the past few months. One of its biggest risks is that it has formed the highly bearish rising wedge chart pattern, whose two lines are about to converge.
A rising wedge pattern often leads to a strong bearish breakdown when the two lines converge. In this case, the drop may push it to the key support level at $45,000, the highest levels in December last year and February this year. Such a drop would be bullish as it will confirm the bullish break-and-retest pattern.
At the same time, the index may drop because its top oscillators like the Relative Strength Index and the Commodity Channel Index are almost becoming overbought.
It is common for a highly overbought asset to pull back. Also, it may drop soon because of mean reversion, a situation where an asset moves back to its historical moving averages.
Dow Jones Index chart | Source: TradingView
AI bubble risks
The other major risk is that there are concerns of irrational exuberance in the artificial intelligence (AI) industry that have contributed to its surge.
A key risk is that the industry is slowing, with some analysts calling it the biggest bubble since the dot-com bubble.
Most of the Dow Jones Index gains in the past few years have been because of the AI industry, with Nvidia’s market capitalization jumping to over $4 trillion.
Nvidia has benefited from the robust spending by hyperscalers like Amazon, Microsoft, Google, and Meta Platforms, which have spent hundreds of billions of dollars this year.
A slowdown in the sector, which Nvidia has already warned about, will likely lead to more downside as investors look for the next major catalyst.
Valuation concerns remain
The Dow Jones Index could retreat as concerns about company valuations in the US as the price-to-earnings multiples have soared to their highest levels in years.
It has a PE ratio of 23, higher than the five and ten-year averages of below 20. Similarly, the S&P 500 Index and the Nasdaq 100 indices have stretched valuations, which may lead to a pullback.
Earnings growth risk
Further, there is a risk that the Dow Jones could face earnings growth risks. The most recent earnings results showed that the S&P 500 Index had an earnings growth of 11.5%, the fourth consecutive quarter of double-digit earnings growth.
However, FactSet data shows that analysts expect that the earnings growth in the third quarter will be less than 8%, a sign that Donald Trump’s tariffs are having an impact on profits.
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