DOW THEORY REVISITED -- DOES THE CURRENT NON-CONFIRMATION MEAN ANYTHING?
DOW THEORY REVISITED... Technical analysts are trying to figure out the meaning of the current divergence between the rising Dow Transports and the falling Dow Industrials. Which brings us to a discussion of Dow Theory. Dow Theory is built on the idea that the industrials (companies that make goods) and the transports (who move the goods) should move in the same direction to confirm a market trend. When one of the two averages fails to confirm a new high -- or a new low -- by the other, that non-confirmation warns of a possible trend reversal. Which brings us to the current divergence. Charts 1 and 2 compare the Dow Transports (Chart 1) to the Dow Industrials (Chart 2) for the last two years. From March 2003 until the first quarter of 2004, both rose together which is the normal pattern. Both then corrected downward until mid-year. That's when they started to part ways. The transports hit a new high during June (first green arrow) while the industrials didn't (first red arrow). The transports hit another high in September (second green arrow) while the industrials again didn't (second red arrow). Not only have the industrials failed to confirm the upside breakouts in the transports. The industrials have actually shown a pattern of falling peaks and troughs while the transports have shown just the opposite. That's worse than a non-confirmation. It means that they're actually trending in opposite directions.
Chart 1
Chart 2
1999 DOW THEORY DIVERGENCE WAS BEARISH ... An eight-year comparison of the two Dow averages shows a non-confirmation by the transports during 1999 (see yellow circle) when they failed to match a new high by the industrials. The industrials peaked within a year. In that case, the Dow Theory non-confirmation turned out to be a valid warning that the new high by the industrials was suspect. That would seem to put a negative spin on the current non-confirmation by the two averages (see red circle).
Chart 3
Chart 4
1980 DIVERGENCE DIDN'T HURT... Going back to the 1970's, I found two other examples of Dow Theory non-confirmation. The first was during 1974. During that bear market year, the transports failed to confirm the fall to a new low by the industrials (see green circle). Once again, the non-confirmation by the transports warned of another trend reversal -- that time to the upside. So far the record is pretty good -- at least until the early 1980's. If you compare the two green arrows, you'll see that the Dow Transports hit a new high during 1980, but wasn't confirmed by the industrials until 1982. As it turns out, that two-year non-confirmation didn't mean anything. I found at least two other major non-confirmations during the 1950's and the decade before 1920. In both instances, the major uptrend was unaffected. All of which suggests that the record of Dow Theory non-confirmations is spotty at best in predicting market reversals. It's also worth noting the last time the transports were stronger than the industrials (1980-1982) it turned out to be bullish for both. That doesn't mean that we should ignore the present divergence. All it tells me is that one of the averages is out of line. That means that either the industrials have to start rising -- or the transports may start falling.
Chart 5
Chart 6
