Translation:The wife was watching him without understanding.
When there are two verbs (guardare, capire) with the same subject (la moglie), the second verb stays in infinitive form. Also verbs used as nouns are always in infinitive form, not in gerund form like in English. This sentence could be understood as either of the two forms (same-subject verb or verb turned into noun).
I just want to clarify some terms. "capendo" is the Italian "gerundio" which corresponds with the English present participle. But it does not correspond with the English "gerund" which means a verb form acting as a noun. In this sentence "understanding" is a gerund which is properly translated with the Italian infinitive which can also be used as a noun. The confusion comes from the English present participle and gerund both having the same "ing" ending. Unfortunately a lot of people including DuoLingo use the term gerund too loosely. DuoLingo even calls their lessons on the Italian "gerundio" "gerund" instead of present participle.
For benefit of any with this question: the lo in front of guardava is the transitive verb's direct object, meaning "him" (or masc. "it").
According to italian.about.com (if I'm reading it correctly), the way to use it intransitively would be, La moglie aveva guardato…. But I look forward to correction on this point.