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THE DOW REPORT
A Change in the Making

Back in late April I warned that there were important non-confirmations in place that had historically proceeded important down turns. We have also been following the badly lagging internals. I have explained that both the non-confirmations and the poor internals were indications of changes that were in the making. These changes are now just beginning to materialize.

On May 12th my Cycle Turn Indicator gave short-term sell signals and early the following week it gave intermediate-term sell signals. The cyclical phasing then suggested a bounce in late May. That short-term low was made on May 24th just as expected. The short-term cyclical phasing also told me that the May 24th low was ideally to be followed by one more down leg before a more significant advance began. As of the close last Friday, June 2nd, the market was still set up to move higher as the May 24th low was then still very much intact. On Monday, June 5th, this short-term positive setup was quickly shattered as the additional leg down that the cyclical phasing was calling for began sooner rather than later.

This brings us to today and we have now had the additional leg down that the cyclical phasing was suggesting. Furthermore, we are now in the window of opportunity in which an intermediate-term bounce can begin. This will probably coincide with the typical “Summer rally.” Unless things turn down much harder than what is now anticipated, this bounce should serve to retest the May highs and last long enough to erase many of the fears that this initial break may have caused. This rally should lull the unsuspecting masses back to sleep.

Based on the evidence at hand today, I look for the coming Summer rally to be a failed rally that will serve as a bull trap. Once that trap is sprung, all the things that have not mattered like the poor internals, the bearish Primary trend under Dow theory, the other important non-confirmations and so forth, should begin to matter in spite of the “Liquidity Factor.” This is when the pain that I discussed as being scheduled for later in 2006 should begin to be widely felt. In the meantime, things are setting up to make this initial leg down look like the typical buy-the-dip correction that has been occurring since this mammoth rally separating Phase I from Phase II began.

In the first chart below I have plotted a chart of the Industrials in the upper window and the Transports in the lower window. In spite of the recent weakness, nothing has changed here. The Primary Trend non-confirmation, as is represented by the red line, continues to hold. All the while, the Secondary Trend confirmation, as is represented by the blue line, continues to hold as well. Until both the Industrials and the Transports break below their previous Secondary low points, there is still some hope of a recovery high. I also want to point out that cycles are not a part of Dow theory, but that cycles do offer a means of trend quantification that Dow theory doesn’t offer. Based on those trend quantification methods, new highs at this point are looking less and less like a real possibility.

Below I have plotted my intermediate-term New High-New Low indictor along with the S&P 500. This is another internal strength measure, and as you can see there has not been any improvement since this indicator broke down in February out of the 4th divergent peak since early 2004.

The same is also true of my intermediate-term Advance/Decline line as can bee seen in the upper window of the chart below.

But, based on the cyclical timing, we should see yet another divergence peak by these indicators in conjunction with the coming Summer rally. One key element to watch will be behavior of these indicators on any rally that develops from here. Once the Summer Rally begins these indicators should move up. But, once these indicators begin to roll back over, buyer beware; and once the intermediate-term Cycle Turn Indicator turns down from the Summer highs, things should really get interesting.

The June issue of Cycles News & Views is now available. So far this year my outlook has been right on the stock market, gold the dollar and bonds has been right on track. In the June issue I give the specific outlook and timing for the rest of 2006. A subscription to Cycles News & Views includes short-term updates three times a week, which include the ever so important Cycle Turn Indicator that is used to identify specific turn points. Things are beginning to change--don’t get blind-sided. Visit www.cyclesman.com for subscription information.

Tim W. Wood

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