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THE DOW REPORT
Confirmations

Yes, according to the Dow theory the Secondary Trend may be bullish, but the recent non-confirmation is warning that this secondary bullishness is on shaky ground. From the short-term low that formed on August 26, 2005 at 10,384 the Industrials have rallied. All the while, the Transports have not only lagged, but have actually moved below their corresponding short-term low. This has in turn created a short-term non-confirmation. When these non-confirmations occur, they are not sell signals per se as we use very specific indicators and rules that trigger the actual signals. But, these non-confirmations do serve as warnings, and unless corrected, they usually lead to a trend change. Another way to think about these non-confirmations is that they are high-probability windows of opportunity for a change in trend to occur.

I have also found the Retail Holders to be a good index to watch as well. In the chart below we have the Industrials in the upper window and the Retailers in the lower window. Notice that with the decline into the late August short-term lows the Industrials held above the short-term low that occurred in early July. Yet, the decline into the corresponding short-term low by the Retailers in early September carried price below the late June short-term low. This in effect has created a non-confirmation between the Retailers and the Industrials. Note that the rally out of the early September lows by the Retailers has thus far been very weak and has already given up most of the advance. Failure of the Retailers to hold above the early September lows would indeed spell more trouble for that sector, and any such weakness should also begin to bleed over into the Industrials as well.

In the next chart below we have the Industrials in the upper window and the Dow Jones Financial Index in the lower window. Confirmations and non-confirmation between these two indexes are also noteworthy.

Notice that as the Industrials were trending down into the October lows last year that the Financials were not confirming these lower lows. With the Industrials moving down at that time and the Financials not confirming, this created positive non-confirmations, which lead to the rally into December. At the highs in December these two indexes were in gear. But then look what happened as the Industrials rallied into their March high. The Financials lagged and since the market was then trending up, this created a bearish non-confirmation which lead to the decline into the April lows. I also want to point out that the Retailers did not confirm the March highs in the Industrials and that non-confirmation was also telegraphing the decline into the April lows.

Now we have the non-confirmation that occurred between the Industrials and the Financials at the August high. That non-confirmation has thus far lead to a decline by the Financials that took them below their short-term June lows and as it stands today, the rally out of the late August lows is weakening.

Robert Rhea used to say that when the averages are not “in gear” that they are shouting "be careful.” Well, even though the Secondary trend is positive, the averages are not “in gear.” Furthermore, we have the Retailers and the Financials that are breaking down and not confirming the Industrials. As long as these conditions exist, the window of opportunity for a change of the Secondary trend is at hand.

Tim W. Wood

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