Should You Ignore The Hindenburg Omen?

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 |  Includes: SPY
by: George Kesarios

I have to admit, I did not really pay much attention to this indicator years ago. In fact, I still don't attention to it today. However, the truth of the matter is every indicator and theory comes from somewhere and usually from real life experience.

Like most technical indicators, we don't know why they work with some statistical relevance, just that they do. Like mathematics, many times we have to take things for granted as an axiom.

I would not say I am ready to give the Hindenburg Omen theory axiom status, but it is important to keep in mind that markets have corrected significantly 25% of the time when the indicator has triggered. If I were a money manager with $2 billion under management, I would say that 25% is enough to make me pay attention.

According to a recent article in the WSJ, the Hindenburg Omen was triggered on June 3. Also according to amateur-investor.net, three very big market declines have followed when it triggered the past.

A Hindenburg Omen event (chart below) occurred in the Summer and Fall of 2007. The first Hindenburg Omen signal occurred in July of 2007 (point A) was followed by an initial 12% correction. Three months later in October (point B) we got another Hindenburg Omen trigger signal, and the S&P 500 (NYSEARCA:SPY) corrected sharply and lost 58% of its value over the next 18 months.

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Another Hindenburg Omen event was triggered in late 1999 and 2000. The first occurred in December of 1999 (point C), at which point the S&P 500 corrected 10%. The second Hindenburg Omen signal occurred in October of 2000 (point E) which was followed by a significant sell off. The S&P 500 lost 50% of its value from March of 2000 through October of 2002.

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The third event occurred in September of 1987 (point F) which was followed by a sharp 36% drop in the S&P 500 over a period of two months.

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We really don't know if the trigger on June 3 will actually lead to a market decline, because a Hindenburg Omen event was also trigger in 2010 and nothing happened. One reason for this (I think) is because everyone was paying attention to it and everyone was writing about it. And when everyone is on alert, usually nothing happens.

This time around however, I have a sense that no one is following what's going on, because everyone is busy buying bubble stocks and trying to find formulas to show that many of these stocks are worth what investors are paying for them.

Among them are stocks like TESLA (NASDAQ:TSLA) that investors are buying hand over fist, the entire SaaS space -- where stocks like Workday (NYSE:WDAY) and Salesforce (NYSE:CRM) are trading at stratospheric valuations -- and many others like LinkedIn (NYSE:LNKD) and Priceline (NASDAQ:PCLN), which are considered new age stocks.

If we get a correction as a result of the recent Hindenburg Omen trigger remains to be seen. However, the possibilities are to the tune of 25%. I think this percentage is enough to keep a sharp lookout for a sharp correction.

Finally, I think this market probably needs a good correction anyway, to shake out investors buying all these bubble stocks. At some point in time, valuations for many sectors have to return to planet earth, and one way for that to happen is via a good correction.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.