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March 26, 2006

Dow Theory Secondary Advance Continues on Fading Internals
by Tim Wood

Since the January 6th bullish confirmation of the Secondary Trend, according to Dow Theory, there have been two additional reconfirmations. This of course, is good news for the market, on a Secondary level, as the Primary Trend still remains bearish. I'm also even hearing lip service being given to Dow theory by some now proclaiming that the Dow theory is bullish. Well, this is a half-truth as most people do not understand that with Dow theory there is the Primary and the Secondary Trend. The Secondary Trend is a movement that is counter to the overall Primary Trend. In other words, it is corrective in nature in that it moves in the opposite direction of the Primary movement. So, if you hear anyone saying that the Dow theory is bullish, that is true, but only at a Secondary degree.

According to Dow theory, there is another misunderstood concept of bull and bear market Phasing. The great Dow theorist, E. George Schaefer, stated: "There are three principle phases of a bear market: the first represents the abandonment of the hopes upon which stocks were purchased at inflated prices; the second reflects selling due to decreased business and earnings, and the third is caused by distressed selling of sound securities, regardless of their value, by those who must find a cash market for at least a portion of their assets." Phase I was the decline that occurred from the 2000 top down into the 2002 lows. Phase II and III are yet to come.

The great Dow theorist of the 1930's, Robert Rhea, described the three phases of the bear market in a very similar way. More importantly, Rhea goes on and states: Each of theses phases seems to be divided by a secondary reaction which is often erroneously assumed to be the beginning of a bull market." Rhea also states: "Such secondary movements seldom prove perplexing to those who understand the Dow theory." Because of my in depth studies of Dow theory, I have maintained all along and continue to maintain the view that the rally, which began at the 2002 low, is the Secondary Reaction separating Phase I from Phase II of this Primary bear market. I also maintain that the reason this Secondary Reaction has been able to hold on as long as it has is because of the excess liquidity that has been thrown at the market in an effort to counteract the decline into the Phase II low.

In any event, as reported last week, the averages yielded the third bullish re-confirmation of 2006. This week I want to look closer at the Transports.

Below is a chart of the Dow Jones Transportation Average verses the Dow Jones Trucking Index. You can see that here too, the Trucking Index recently bettered its previous Secondary high point as well. Therefore, this sub-sector within the Transports is in gear with the entire Transportation sector. But, there is also a negative here in that the Truckers have now fallen back below their recent breakout and support level. If this weakness continues, it will begin to weigh on the overall Dow Jones Transportation Average.

Next, is a chart of the Dow Jones Transportation Average verses the Dow Jones Rail Road Index. This index remains in gear with the Transports and as of this writing is still holding above its breakout level. A break here below the recent breakout point would of course add even more weight on the overall Transportation Average.

Next, we have the Dow Jones Transportation Average verses the Dow Jones Air Freight Index. The Air Freight index is the strongest in that it is further above its breakout and support level.

The first and thus far minor concern is now appearing with the Dow Jones Trucking Index falling back below support levels. If the other indexes can hold and if the Truckers can resume their advance, then this weakness is no big deal. But, should the other indexes fall below their breakout points, then something else may be in the wind. A drop below previous Secondary low points would definitely be a clue that a change in trend has occurred. Until such time, the Industrials are in gear with the Transports, which are in gear with the Rails and the Air Freight sectors, while the Truckers are beginning to slip a little.

The poorest performing sub-sector of the overall Dow Jones Transportation Average is the Marine Transportation sector. I have plotted this chart below. On the bullish side of the coin, the Marine Index needs to at least better its December 1st Secondary high. Should this occur from this level it would establish a higher low as well as a move above the previous Secondary high point, which would in turn set this index up to get back in the game. On the bearish side of the coin, failure to better the December 1st high should be met by more weakness.

The bottom line is that in the wake of the now three Secondary reconfirmations for 2006, price continues to hold and overall the sub-sectors within the Transports remain basically sound with the exception of the Marine sub-sector. But, the bad news continues to be the poor and deteriorating internals. Healthy breakouts come in the wake of accumulation periods and then the breakout occurs on expanding internals. What we have seen is just the opposite. I showed you last week a chart of Advance Decline data for the Nasdaq. This week I want to show you a chart of the NYSE Intermediate Term Breadth Line that I use. Note on the chart below that just as with the previous breadth related indicators that I have shown you, this indicator also shows that each rally during 2004 and 2005 occurred on poorer and poorer breadth. If 2004 and 2005 had been a real bona fide "accumulation period" we would have seen expanding breadth rather than contracting breadth. Now look at the breadth in relation to this "break out." It's actually falling from yet another lower peak of this breadth indicator.

Bull market breakout? Hardly! No, this is more like a "Bull Trap" and the combination of the Dow theory Phasing with poor internals supports this notion. Just as the recent reconfirmation of the Secondary Trend suggests, this is a continuation of the rally separating Phase I from Phase II of the Dow theory secular bear market that began in 2000. This advance has been unprecedented given the technical backdrop in which it has occurred. No doubt about that! Also, as of this writing the Secondary Trend remains positive. No doubt about that either! But, there is a change in the wind; however, one thing that hasn't changed is the meaning and end result of this breadth data. It takes buying for an advance to continue and the buying is shrinking as can be seen by this breadth indicator. Furthermore, it's shrinking into the rally separating Phase I from Phase II of the ongoing bear market that everyone seems to discount. Well, no amount of liquidity can fix the shrinking breadth data and this should be obvious as we all know that the liquidity pump has been in high gear, yet breadth has been contracting for over 2 years. Now we have a "breakout" and it shrinks even further! Yes, this entire 2004 to present act of levitation is a direct result of liquidity. At some point, the lack of breadth will override the liquidity factor and that's when gravity will override the levitation act. That's when the financial mess that has been extended and made even worse by this excess liquidity will hit the fan. That's when "control" is lost and Phase II begins. Until such time, this levitation act and Secondary Reaction continues, but on increasingly thin ice.

If you would like more specifics as to our 2006 outlook, the cyclical implications, trend quantification with statistical expectations, expected turn points, price targets, access to updates on my Cycle Turn Indicator, coverage of the dollar, gold, bonds and much more, then visit www.cyclesman.com for subscription information. Get armed and get the technical and statistical facts.

Tim W. Wood
Cyclesman.com

Copyright © 2004-2009 by Tim W. Wood. All rights reserved.

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