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THE DOW REPORT
Another Look at the Summer Rally - Take III

In the June 30^th WrapUp I reported to you that the “Summer Rally” had begun. As the market rallied into early July, I wrote in my short-term updates to subscribers that a short-term top was due and that the market should move lower once again into a short-term low in July. As it turns out, this is exactly what happened, but in the process the Industrials moved below the June low on an intra day basis. On a closing basis the June low held. When looking at the S&P 500, the June low held on both a closing and an intra day basis. What this left us with is a double bottom and the attempt at a summer rally is still in the making. If you listened to last week’s interview I said then that I was looking for the advance out of the July low to continue, and it did. However, I still maintain the position that overall this summer rally is a counter-trend affair. Yes, it could better the May highs, but I have yet to see anything to change my mind about this at this time. I still believe that this rally will most likely be a failure.

Now, I want to take a look at a chart of the Industrials and the Transports. It seems that everyone was watching the Transports lead the way up, but now that the Transports have become so weak it seems that few want to talk about it. Below is a chart and the Industrials are shown in the upper window with the Transports in the lower window. The Transports are obviously weaker in that they have not been able to hold above their June low. I will be covering the details of this from a Dow theory perspective in the August newsletter.

Next I want to take a look at the Industrials verses the Dow Jones Top Ten Index. The Top Ten Index is an index that approximates the Dogs of the Dow and is plotted in the lower window of the chart below. What I want to point out here is that the Dogs have been on fire. This week alone they were up 5.02% and for the year they are up 11.19%. These figures are excluding dividends. By comparison the Industrials were up this week 3.23% and for the year they are up 4.69%. So clearly, the Dogs are out performing the Industrials.

However, I do not like the fact that there continues to be a non-confirmation between the Industrials and a subset of the same average. Note that the last time this occurred it was the Industrials that were the strongest. Nonetheless, that non-confirmation lead to the 2000 top. In order to negate this divergence and turn this situation positive, we must see the Industrials better their May highs.

It’s been a while since we looked at the Retailers and now may be a good time to do so. I have plotted a chart of the Industrials in the upper window of the chart below and the Retailers in the lower window. The last time we looked at this chart I pointed out the long-term divergence that began between these two averages last year. This divergence continued all the way up into the May high. Just as I have warned before, divergences between these two averages is not a healthy sign, and this has obviously proven correct once again as the Industrials have softened. But, more importantly the Retailers have softened to the point that they have recently moved below their October 2005 intermediate-term cycle low. As a result of this weakness, the cyclical structure of the Retailers has turned bearish. Now I want to pose this question: Unless the Retailers can mend this technical damage, how can the Industrials move to all time highs? My point here is that as long as the Retailers are lagging and until they begin to perk up, I just can’t see the Industrials moving substantially higher. Sorry!

So, according to Dow theory, the Secondary Trend remains bullish, but the action in the Transports is not a good sign. Then when we look at the cyclical phasings combined with the internals and non-confirmations, I continue to have my doubts about the longevity of this advance. I said in January that the first half of the year would see the gain and that the second half would see the pain. At this time I see no reason to deviate from that stance. Thus far, my 2006 forecast has been right on the mark, and I now think the stage is being set for the pain. In the interim, the Summer Rally continues.

I have guided subscribers through each crook and turn with my very unique Cycle Turn Indicator. This indicator is key at guiding us as this setup continues to materialize and knowing the direction of the market is as simple as following this indicator. If you are interested in a statistical and technical based source that also utilizes Dow theory and provides turn points for gold, the dollar, bonds and the stock market, then Cycles News & Views may be for you. Please see www.cyclesman.com.

Tim W. Wood

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