The Dow Report: Sector Watch May 14

By Tim W Wood CPA, May 14, 2004

In this observation I want to take a brief look at a few different sectors in an effort to determine just how wide spread the recent market weakness has been. Obviously, we can't look at more than a hand full of sectors each week, so in this week's session I want to look at the Dow Jones Industrial Average vs. the Dow Jones Transportation Average. We will then expand this view as we examine a few other indexes.

Since February there have been numerous divergences or non-confirmations between the Industrials and the Transports. However, at this time my primary focus is on the longer term non-confirmation that has been unfolding since late November. As you can see on the chart below the Industrials have now violated their March 24, 2004 low which occurred at 10,048.20. Given that the March 24, 2004 low was a low of intermediate term degree, the violation of this low by the Industrials definitely carries bearish implications.

The Transports, on the other hand, have managed to hold above their March 22, 2004 low, which marked their most recent intermediate degree low. This does carry bullish implications for the Transports. However, this positive undertone currently being seen by the Transports does not in any way negate the fact that we are still very much operating under a Dow theory sell signal that was generated on March 10, 2004.

The bottom line here is that as long as the Transports can hold above their March 22, 2004 lows at 2,750.80 there is a glimmer of hope for the current setup. But, if the Transports were to now close below 2,750.80 we would then have a reconfirmation of the original Dow theory sell signal, and at that point the Bear would be in full control according to Dow theory. Therefore, at this time we should simply be watching the Transports for reconfirmation of the Bear.

The next chart below is of the Dow Jones Rail Index. This index topped out in December ahead of the Industrials and the Transports. As with most indexes, the Rail Index made its last intermediate term low in late March. Since the March low the Rail Index has just completed a short-term cycle. This short-term cycle low occurred on May 12, 2004 and is marked with a "t." The fact that this low occurred above the March low as well as the shorter term April low is a positive sign for this index. In order for this positive development to continue we must now see a rally above the April highs. Should a break below the March lows occur it would serve as a very bearish indication because it would be a violation of a low of intermediate degree and should be followed by continued weakness into the intermediate term low in or around August. From a technical perspective this index has shown much more positive developments since the March low than the Industrials. Technically the Rail Index is showing the same strength as the Transports and it will take a break below the March lows to turn this intermediate term picture negative.

The next chart below is of the Dow Jones Marine Transport Index. Again the March low served to mark the last low of intermediate degree. Notice how in this index price failed to move back above the early March highs once the rally out of the intermediate term low began. This set up a "failure" like I have talked so much about over the last several months. From this failed high, note that the March intermediate term low was violated. This violation was indeed a bearish blow for this index and is suggestive that we should see overall continued weakness as we move into the next intermediate term low. This index is now at a short term cycle low, thus we should see a short term rally develop. But, based on the violation of the March low, this rally should be another failure. It would take a rally back above the early March highs to turn this technical picture bullish and I currently do not expect to see this occur.

The next sector I want to examine today is the Dow Jones Heavy Machinery Index. Not to sound like a broken record here, but again, the last low of intermediate term degree occurred in March with this index as well. From that low the previous intermediate term high, which was made in January, was bettered. This was no doubt very positive action. From the April high we have now moved into a short term trading cycle low. This low did violate the March low on an intra day basis and from a cyclical perspective this is all that is required to indicate that the intermediate term trend has now turned down. I personally prefer to see violations on a closing basis, but in this case this has yet to occur. The thing to watch for here is a failed rally above the recent April high. Such a failure will likely set this index up for a decline below both the March and the May lows. Should this occur the intermediate term outlook for this index would indeed be bearish. So, in my opinion, any failed rally would be a bearish setup that should be followed by more weakness. Watch for that failure.

The last chart I want to look at today is the Dow Jones World Stock Index. Sorry, but I have to say it one more time. The March lows also marked the last intermediate term degree low in this index as well. From that low this index rallied but also failed to move above the previous intermediate term high seen in February. From this "failed" rally this index immediately turned down and has now violated the March lows. It is the violation of this previous intermediate term low that makes this technical picture so bearish.

In addition, we also have a topping pattern seen in this index that is known as a broadening top. This is representative of the blue trend lines. The rally into the April high is also known as a "failure" within this pattern. This is true because in perfect world the April high would have re-tested the upper blue line. Therefore, this is considered a failure and a sign of weakness because of the inability to challenge this upper limit. This broadening top formation is a very bearish formation and the violation below the second low point within this pattern (the March low) suggests that the topping process is complete and that the decline should now be underway. We are now at a short term trading cycle low and thus a short-term bounce is now warranted. However, this bounce should also be a failure and once complete, this decline should resume in earnest. Also, at this point in the pattern the bounce into the trading cycle top could be very muted.

In summary, the bag is somewhat mixed with a negative bias. The Industrials have made a bearish break below their March lows while the Transports and the Rail Index have held above their respective lows. As long as these indexes hold above the March lows their technical outlook does at least have some hope. The Marine Transportation Index has broken below it’s March low and has thus turned this index bearish as it should have now seen its top. I suspect that this index is a precursor of what is likely to be seen in the Transports and the Rails once this short-term advance concludes. The first sign that this suspicion is correct will come if the rallies out of the current short tem trading cycle lows are failures.

The Heavy Machinery Index has not yet clearly broken as it has basically held above the March lows on its retest. The key here is to also watch for a failure as we are now set to rally into a short term trading cycle high and I expect to see this rally fail. Such a failure will be our cue that this index has too likely topped and should then be followed by continued weakness into the next intermediate term low.

In my eyes it is the Dow Jones World Stock Index that is the most ominous. This index tells me that the current stock market weakness is WORLD WIDE and is not just limited to the United States. It also tells me that these other indexes should soon follow. My current read on this index is without a doubt bearish as we saw a failed rally of intermediate degree that has already been followed by a downside break of intermediate term degree. Should this technically bearish setup change I will let you know, but until then there is simply no other way to view this but negatively. Unless the current technical picture quickly changes, the equity markets likely have serious problems just ahead.

Those not familiar with my methods should read the Observation from May 7, 2004 as it will help you to understand the significance of the violation of the low points that I keep referring to. The key is that all major indexes made very important intermediate term lows in March. These indexes are now being put to the test. With the World index in the technical shape that it’s in, if we begin to see the March lows violated, it could really be a mess. My approach to the markets includes Dow theory and cycles. The cycles piece simply allows for a quantification of the moves of various degrees. If you are interested in this type of analysis, I urge you to consider Cycles News & Views as your source. I will include a free copy of my Gold Report with any subscription or renewal.

To contact me, please visit my website at www.cyclesman.com or call 318-342-9038.

Tim W. Wood

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Tim W. Wood CPA
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