The Dow Report: A Brief Follow Up on Key Non-Confirmations

By Tim W Wood CPA, October 21, 2005

A few week's ago I addressed the fact that the recent decline had been confirmed by some indexes, but unconfirmed by others. From a Dow theory perspective the only confirmations that count are those which occur between the Industrials and the Transports. Today, I want to revisit these non-confirmations.

Below is a chart of the Industrials vs. the Transports. From a strict Dow theory perspective, we must use close-only charts and ignore the opens, highs and lows. In doing so, the decline into the recent lows carried the Industrials below both their September and their July lows. To date, the Transports have held above these levels. This in turn has created short-term non-confirmations between these two indexes that continue to hold. Until/unless both averages move above or below their corresponding high or low points, the averages are not considered to be "in gear." Furthermore, when the averages are not "in gear," their movements are not to be trusted until confirmation occurs. At such time that confirmation by both averages occurs, they are then considered to be back "in gear" at that level.

Next, we have the Industrials plotted in the upper window of the chart below and the Retail Holders Index in the lower window. I have marked the non-confirmation that have occurred at many of the recent tops and bottoms since 2004. You can see that when these non-confirmations occur as the market is declining, they lead to bottoms, and when they occur as the market is advancing, they lead to tops. I have marked a few such examples in blue on the chart below. I have also marked a very important longer-term non-confirmation in red.

Moving forward to our current situation, we have a non-confirmation that occurred at the recent price lows. This non-confirmation has been a month in the making, which is a relatively short time in terms of many of the previous non-confirmations. But, there is an even shorter-term wrinkle now developing. Notice that as a result of this downside non-confirmation, the Retailers have advanced above their late September short-term high. Yet, the Industrials haven't. Therefore, the Industrials are either simply lagging the Retailers or perhaps the advance out of the recent low is already over.

In looking at the Industrials vs. the Russell 2000 below, we find that these two averages are in gear with each other. We also find that the strength of the most recent up move by the Russell has been weaker than that of the Industrials.

From a Dow theory perspective, the issue is whether or not the non-confirmation between the Industrials and the Transports can continue to hold and if the Industrials can join the Transports, or if the Transports begin to weaken and join the Industrials. When looking at the Industrials vs. the Retailers, we have both a short-term bearish and a short-term bullish non-confirmation. One of these non-confirmations is going to be proven correct while the other one will be proven wrong. Once the market works this out, it will serve as confirmation of the most probable short-term direction. Longer-term, we still have non-confirmations between both the Industrials and the Transports. Also, we have the longer term non-confirmations between the Industrials and Retailers as shown in red in the chart above. Short-term the small caps are in gear with the Industrials, but longer term we also have bearish non-confirmations between these averages as well.

The October issue of Cycles News & Views is a beefy 25 page issue. In this issue I give specific timing windows for price, price targets, trend expectations, and more. This issue covers the stock market, gold, the dollar and bonds. Given the current state of the markets, you should have the technical data provided in this issue. For more information please visit www.cyclesman.com

Tim W. Wood

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