The Dow Report: Dow Theory February 13
By Tim W Wood CPA, February 13, 2004
The Dow Jones Industrial Average has managed to move to yet another high this week. However, this high has thus far not been confirmed by the Dow Jones Transportation Average. This has set up what is known as a Dow theory non-confirmation. In fact, the Transports have also moved below their last secondary reaction low, which occurred on November 21, 2003. This intra-day low occurred at 2,837.42. From a Dow theory perspective, we use the daily close and that was also seen on November 21, 2003 at 2,837.42. So we now have two closing lows below both of these levels. This can be seen by the blue line on the chart of the Transports below. This violation strongly suggests that the intermediate term trend for the Transports has now turned down. It would take a move by the Transports back above the January highs to correct this condition. Anything is possible, but given the overbought levels of the market it is doubtful if this non-confirmation will be corrected. Any closing low below the February 4, 2004 low at 2,822.11 will serve as confirmation that this decline is just beginning. Such a decline would also serve as additional confirmation that we are not likely to see the Dow theory non-confirmation corrected any time soon and we should then expect to see the Industrials follow the Transports downward.
Also notice that I have marked the 50% level for the Transports on the chart below. This level is marked with the horizontal red line at 2,862.85. The 50% principle was developed by the great Dow theorist, E. George Schaefer. I feel that this is once again an appropriate time to take a look at this principle. Mr. Schaefer shows the application of this principle only to the Industrials. I do not see any reason that this same principle cannot be applied to the Transports. Mr. Schaefer stated in his 1963 book, How I Helped More Than 10,000 Investors To Profit In Stocks, "In my endless search for clues to the stock market's behavior, I have developed a concept which at times has proved extremely useful. This is my 50% Retracement Concept. While it is primarily helpful in reinforcing conclusions I have drawn from my other technical studies, it has given me great comfort and reassurance during the trying times when the market has fallen to low ground-in 1949, in 1953, in 1957, in 1960 and in 1962." I would indeed consider the current times with the market as "trying times."
Mr. Schaefer applied this principle to secondary movements that served to correct the longer-term primary movements. These primary movements were periods of several years. Mr. Schaefer used closing prices, so in the application of his principle I will do the same. Let's now apply Schaefer's principle to our present situation.
The bull market top for the Transports occurred onMay 12, 1999 at 3,783.50. So far, the bear market bottom has been 1,942.19 which occurred on March 11, 2003. The half-way point is 2,862.85. The basic concept behind this principle is that when a secondary reaction carries a market above this 50% level it is considered bullish as long as the market can hold above that level. We violated this level to the downside last week. However, we are now back above it. If the Transports fail to hold above this level it will indeed be a bearish sign for the market.
We have two very important levels to watch in the Transports. The first one is a move back below the February 4, 2004 low at 2,822.11 and the second one is the 50% level at 2,862.85. Violation of these two levels should prove to be bearish for the entire market.
The CRB Index
The 3-Year Cycle
I monitor the long-term cycles in the CRB index in an effort to help me with the Big Picture. The dominant long-term cycle here is the 3-year cycle. To be exact, this cycle averages 36.4 months in duration. This cycle last bottomed in November 2001 at 184.25. January 2004 concludes the 26th month for the current cycle. Please see the monthly chart below. Note that the monthly 5 3 3 stochastic is now rolling over from an overbought level. When we combine this fact along with the timing aspects, we have to consider the fact that we should be nearing the 3-year cycle top. In order to confirm this top, we have to turn to the price action of the shorter-term seasonal cycle.
The Seasonal Cycle
History shows that this cycle has an average duration of 10.83 months. This cycle last bottomed on March 25, 2003 at 226.50. January 2004 concludes the 10th month for the current cycle. See the monthly chart on page 14. The timing is now ripe for a turn in the seasonal cycle. History shows that there has never been a seasonal cycle with an advance of 8 months or more that violated the previous seasonal cycle low once the cycle turned down. Therefore, we can expect to see the coming seasonal cycle low to occur above the previous low at 226.50. From this higher seasonal cycle low, we can then look for the next seasonal cycle to begin moving up. It is this next seasonal cycle advance that will help us confirm the 3-year cycle top. If the next seasonal cycle fails to move above the current seasonal cycle high, then we will know when this cycle turns down that the 3-year top is in place. Alternatively, it is possible that the next seasonal cycle will make another high. This would likely coincide with another push up in the gold and down in the dollar. If so, this should certainly mark the 3-year cycle top. So, in either case, we can expect to see one more seasonal run up after the coming seasonal cycle low. It is then from that next seasonal cycle top that the decline into the 3-year cycle low should begin.
CRB In Summary
I am currently of the opinion that the upward advance in the CRB is not representative of the reemergence of inflation. No, I am of the opinion that this has simply been the upward movement of the current 3-year cycle. I am also currently of the opinion that we have possibly seen or could see the top of this cycle with the next seasonal cycle advance. Either way, we are close to the top. Once the 3-year cycle turns down, the full effects of K-winter should be felt. In other words, the advance by the current 3-year cycle is a large counter trend move like that presently being seen in the stock market. To clarify, I believe that the stock market is in a giant bear market and that the rally out of the March 2002 low is a counter trend rally which was born as a result of the 4-year cycle advance. Well, the same is true in the CRB. According to history, K-winters are deflationary events. So commodities should be in a giant bear market and the rally out of the 2001 low should be nothing more than a counter trend rally created by the upward movement of the advancing 3-year cycle. Once this cycle tops, the deflationary forces of K-winter should then resume.
It is also worth noting that in the history of the CRB index we have only seen two consecutively higher 3-year cycles. This occurred between 1977 and 1980. Now let me point out that this was right at the height of the previous K-wave Summer, which is known to be marked by runaway inflation. Both the historical patterns of the 3-year cycle and the fact that we are in the Winter season shows that we should not expect to see the next 3-year cycle advance above the current cycle. Therefore, given the evidence at hand today, I am of the opinion that the current advance in the CRB is limited and that once the 3-year top is established, we can then look for the deflationary effect of K-wave Winter to "bear" down. I will be monitoring the progress of this long term cycle and give updates as applicable. I can only guess at this point because I do not have the confirmation to prove it, but my best guess is that the 3-year cycle top is now most likely in place.
It remains to be seen, but given the current facts surrounding the CRB index, I want to throw out the possibility that its top could be occurring simultaneously with the 9-year cycle top in gold. Gold bugs, this possibility must be considered. It is far too early to confirm this possibility as I will have to see what the price action of the next seasonal cycle brings. I will get into this later when it becomes much more timely. For now, I just want you to be aware of the possibility and for now, it is only a possibility. I will examine the facts surrounding this as they unfold.
If you would like a serious in-depth technical and statistical analysis that supports these general statements, I urge you to consider a subscription to Cycle News & Views. The current technical setup could have profound implications for the market. Anyone that has a vested interest in the market will likely be served well to know the statistical odds that this market now faces. I urge you, please don't let the Hope & Hype of Wall Street cause you to be blind-sided. Any new subscribers can call me and I will spend time with them on the phone in an effort to get them up to speed on the current market setup.
Tim W. Wood
© 2004 Tim Wood