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August 26, 2006

A Look at Current Non-Confirmations
by Tim Wood

During the decline in May and into June my analysis was telling me to expect an intermediate-term low in mid-June and that from that low the "Summer Rally" would begin. I also reported this here as well. Now, the "Summer Rally" is beginning to run into trouble. Yes, this rally is still intact, but all is not well. Until July, both the Industrials and the Transports were in gear on a Secondary level. This changed in late July and it is for this reason that the "Stock Market Barometer" is now sending its warnings of changing conditions.  

Below is a chart of the Industrials in the upper window and the Transports in the lower window. As the market moved up into the May high you will find that both averages were pretty much in sync and were making new highs together. As the market rolled over into June they both made a joint low together. Then, came the rally into late June and early July. Again, both averages were in gear together. The trouble came in late July when the Transports broke down below their June low, which is illustrated by the blue line on the chart below. Note that the Industrials held above their corresponding June low and in doing so this created a non-confirmation. From the July low the Industrials have moved up and have actually bettered their early July high, while the Transports have continued to lag. This non-confirmation is illustrated in red. So, as I read this we now have a dual non-confirmation in that we have both an upside and a downside non-confirmation in place.

Below are a few quotes from the great Dow theorists of the past on this subject:

Robert Rhea - "The most useful part of the Dow theory, and the part that must never be forgotten for even a day, is the fact that no price movement is worthy of consideration unless the movement is confirmed by both averages."

Robert Rhea - "A wise man lets the market alone when the averages disagree."

Robert Rhea - "When the averages disagree they are shouting 'be careful.'"

William Peter Hamilton - "The movement of both the railroad and industrial stock averages should always be considered together. The movement of one price average must be confirmed by the other before reliable inferences may be drawn. Conclusions based upon the movement of one average, unconfirmed by the other, are almost certain to prove misleading."

William Peter Hamilton - "Dow's theory stipulates for a confirmation of one average by the other. This constantly occurs at the inception of a primary movement, but is anything but consistently present when the market turns for a secondary swing."

William Peter Hamilton - "When one breaks through an old low level without the other, or when one establishes a new high for the short swing, unsupported, the inference is almost invariably deceptive."

William Peter Hamilton - "Indeed it may be said that a new high or a new low by one of the averages unconfirmed by the other has been invariably deceptive. New high or low points for both have preceded every major movement since the averages were established."

William Peter Hamilton - "The two averages may vary in strength, but they will not vary materially in direction especially in a major movement. Throughout all the years in which both averages have been kept, this rule has proved entirely dependable. It is not only true in the major swings of the market, but it is approximately true of the secondary actions and rallies. It would not be true of the daily fluctuations, and it might be utterly misleading so far as individual stocks are concerned."

Aside from Dow theory there are also other indexes that I have found to be worthy of monitoring when it comes to confirmations and non-confirmations. One such index is the Dow Top Ten Index. I like to watch this index because it is a subset of the Industrials and consists of the top ten dividend yielding stocks within the Industrials. So, the logic is that when the subset is not in agreement with the primary index, something is wrong. I have plotted a chart of the Industrials in the upper window of the chart below. The Top Ten Index is plotted in the lower window. From the rally out of the June low, the Top Ten Index has managed to better its May highs. Yet, the Industrials have not. Common sense tells us that anytime an index is not in gear with a subset of that index there is internal erosion.

Additionally, I like to compare the Retailers to the Industrials. When the Retailers lag it tends to indicate that all is not well with the Industrials. As an example of this I have marked a few of the more recent upside non-confirmations between these two indexes in blue on the chart below. In the upper window I have plotted the Industrials and in the lower window we have the Retail Holders Index. The first upside non-confirmation shown in this chart occurred between December 2004 and March 2005. This resulted in the decline into the April 2005 intermediate-term cycle lows. Note that at these lows there was a downside non-confirmation, marked in red, that formed warning of the low.

Next came the longer-term non-confirmation that unfolded between June 2005 and May 2006. This non-confirmation lead to the decline into the recent June/July lows. Also note that within the context of this longer-term non-confirmation there were three shorter-term upside non-confirmations, which are also marked in blue and which also lead to corrective market action. In addition, at the lows we saw short-term downside non-confirmations that lead to higher prices, but still were within the longer-term non-confirmation.

At the more recent June/July low we again had another downside non-confirmation, which served to signal that a low was in the making and sure enough this is where the "Summer Rally" began. Now I want to point out that we once again have another upside non-confirmation in the making, which again is marked in blue. Therefore, just as the Industrials and the Transports are kicking off non-confirmations, so are the Industrials and the Retailers. The warnings that these non-confirmations are now signaling is consistent with my original forecast for 2006. Until/Unless these non-confirmations are mended, caution is warranted.

If you are interested in a statistical and technical based source that also utilizes Dow theory and provides short and intermediate-term turn points for gold, the dollar, bonds and the stock market, using the Trend and Cycle Turn Indicators, then Cycles News & Views may be for you. The August issue is now available and it contains all of the statistical probabilities and expectations for the stock market for the rest of 2006. A subscription also includes short-term updates three nights a week. Please see www.cyclesman.com/testimonials.htm.

Tim W. Wood
Cyclesman.com

Copyright © 2004-2008 by Tim W. Wood. All rights reserved.

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