The Dow Report: A Look at a Few Current Non-Confirmations

By Tim W Wood CPA, July 8, 2005

The first chart below is of the Dow Jones Industrial Average and the Dow Jones Transportation Average. As I have explained many times before, but just for clarification I'll say it again, both bull and bear markets unfold in three phases. The decline into the 2002 low on the Industrials was only Phase I. The rally out of that low was the ever so common rally that serves to separate Phase I from Phase II. The blue line marks the Primary non-confirmation that has occurred with the advance out of Phase I lows.

It may be a little hard to see in this chart, but the Industrials made a higher high in June than the Transports did. This in turn created a Secondary non-confirmation and is marked in red on the chart below.

This Secondary non-confirmation is warning us that the stock market barometer is seeing trouble on a shorter term horizon as well. Like Robert Rhea said "When the averages disagree they are shouting ‘be careful.’" The averages are shouting at two levels now. When this occurs it pays to listen to the warnings, because the market is beginning to discount bad news in spite of the fact that all we hear from the mainstream is that the economy is good and that everything is going to be fine.

Next I want to take a look at the Industrials, shown in the upper chart below, vs. the Retailer Holders Index shown in the lower chart. I have found that non-confirmations between the Industrials and the Retailers are also warnings that should be taken to heart. As an example, the Retailers made a price high last November while the Industrials topped out in March. Therefore, the Retailers did not confirm the March high seen by the Industrials. This non-confirmation lead to the decline into the April lows. Now, once again we are seeing another non-confirmation developing between these two averages. The Industrials topped out in June, while the Retailers continued higher into early July. This non-conformation is also a "secondary" non-confirmation if you will, in that it has occurred at a level that is subordinate to the November/March non-confirmation. Therefore, we have non-confirmations at multiple levels and this simply serves as warnings because the indexes are not all "in gear."

Below is a chart of the Industrials and the Morgan Stanley Consumer Index. You can also see that these indexes did not confirm each other at the March high and again, this lead to the decline into the April lows. Now, we once again have a non-confirmation between these two indexes as the June highs made by the Industrials have not been confirmed by the Consumers Index. Furthermore, the Consumer index has now violated its April lows.

The next non-confirmation of importance is between the Industrials and the Nasdaq 100. Trouble began here when the NDX began breaking down in January. Then, as you can see, the March high seen by the Industrials was not confirmed by the NDX and this lead to the decline into the April lows. Now, just as with the indexes above, there are non-confirmations that have occurred at the June highs between these two averages.

So, not only are the Industrials not "in gear" with the Transports, but they are also not "in gear" with many other important averages. As the Dow theory suggests, these non-confirmations are telling us that the stock market barometer is forecasting stormy conditions and caution is advised.

If you would like more specific technical research on the stock market, gold, the dollar or bonds, then you should consider Cycles News & Views. My work is grounded in market history such as the Dow theory. I also use cycles analysis as a method of developing quantified expectations for future price movement. When combining these quantified expectations with the Dow theory and my Trend and Cycle Turn Indicators, we are provided with a unique perspective of the market with long, intermediate and short term expectations.

Tim W. Wood

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Tim W. Wood CPA
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