The Week Ahead: Demystifying the Hindenburg Omen

What a week! First the Hindenburg Omen signals the stock market might be due for one of those nasty crashes it experiences from time to time, and then the wheels fell off.  

The Omen is a dark technical indicator of stock market strife to come. The crystal ball signaled trouble twice this past June… you remember June, the worst June in 78 years… In the last 25 years in fact, no market crash has occurred without a signal from the Omen. But, it has flashed more often than just before market nastiness, so it’s not the end all tell all forecaster either.  

In any event, the alarm is triggered when a significant number of NYSE stocks are marking new highs and lows at the same time. I have a theory of my own for why this is relevant, and how it may interrelate with the eventual catalyst that brings about sudden market death.  

Capital, you see, is a pig, and even in tough times, it finds something to eat. When the broad market is marking new lows, why else would a significant number of stocks also reach new highs? The answer is because of capital flows.  

Capital finds profit, and drives pockets of valuation bubbles, even in broad market decline. In fact, during a period of broader decline, there are fewer places to hide, so to speak, and so capital amasses atop the times’ handful of success stories. This creates an unnatural bubble in a small segment of stocks. So, I expect that when that middle class of stocks disappears, as is the case today, and capital is amassed in a few names, perhaps the market demands reversion. 

Capitulation 

Capitulation occurs when the broad market gives up on stocks altogether. In a scenario like that defined by the Omen, a catalyst-event could leave money believing no equity investment were safe, leading capital out of the few inflated names that were hitting new highs. These questionably valued winners could deflate in a hurry in that case.  

The newly dislocated capital flowing out of those stocks is not likely to reallocate to the already bloodied names of the street either. In fact, stubborn long-term holders of losing shares also typically give in as well, and so capitulation is related with market bottoms. These exacerbated sell-offs leave stocks bone dry of capital, and almost always as cheap as they get.  

We hope we’ve demystified the Hindenburg Omen a bit for you, and perhaps presented a reasonable case for why the dark predictor is so effective. 

Last Week 

With little economic catalyst last week, the market wandered until two disturbing potential catastrophic catalysts came to the fore. The first was Iran. The former Persia tested more than a few missiles, and of all sorts. The tests included disturbing land-to-sea rocket launches over the Persian Gulf and missile firings with range enough to reach Israel. The United States then warned Iran that it should not underestimate the resolve nor capability of the Red, White and Blue to defend its ally. Finally, the Jerusalem Post reported that Israel had been staging practice flights over Iraqi territory, in preparation for an attack on Iran.  

Needless to say, oil, which had given up sharp ground to start the week, recovered more than enough ground to actually enter into record territory on Friday before settling back. Last week, we discussed oil, the dollar and the central banks in an interesting article entitled ECB and Fed Manipulate Dollar and Oil.  

Finally, we would be remiss if we failed to mention the panic that occurred in the financial sector, specifically in Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) shares on Thursday and Friday. Concerns arose that the two might not be adequately capitalized, and might require government bailout. That sounds like salvation right? So why did the shares tank on Thursday and Friday then? That question shamefully befuddled more than a few talking heads.  

Well, let’s simply look back to Bear Stearns (now under JP Morgan Chase (NYSE: JPM), and how shareholders made out when that financial stalwart was “bailed out.” Bail out, you see, preserves the interrelated financial system, not the shareholders of the distressed firm. Needless to say, with all the disturbing news flow, the Dow Jones Industrials, which entered bear market territory (marked by 20% decline from peak) the prior week, shed another 1.7% last week.  

The Week Ahead  

The coming week offers June Retail Sales, important inflation data in the Consumer Price Index (CPI), FOMC Meeting Minutes that might offer insight into the Fed’s mindset and finally regional manufacturing reports. Also, earnings season gets a little heavier, with news originating from many companies, including: Tuesday – Intel (Nasdaq: INTC), U.S. Bancorp (NYSE: USB); Wednesday – Wells Fargo (NYSE: WFC), Yum! Brands (NYSE: YUM); Thursday – Google (Nasdaq: GOOG), Merrill Lynch (NYSE: MER); Friday – Citigroup (NYSE: C) and Honeywell (NYSE: HON).

Comments

[Paul Lopez:]

Markos - good article. I think the market is more like the Heisenberg Uncertainty principle in quantum mechanics, when you try to measure the location, you can't measure the velocity and vice versa. The rapid rotation between sectors if unusual as investors try to feed the pig. Last couple of weeks it was BioTech & Healthcare. There are several sectors in play but energy stays at the top of the list. Not sure which direction it goes (Oil - Tech - Steel - Ag - Healthcare), only one missing is Finance and without that stabilizing, we'll say in bear territory.

2008 Jul 13 09:19 AM

[John Lounsbury:]

Paul Lopez - - -

Excellent observation about the uncertainty principle. There is one tiny flaw, however. In physics, if you give up some knowledge of position you gain some knowledge of velocity. I think that in your analogy using price velocity and value, for example, I don't believe giving up knowledge of which way the market is moving increases your knowledge of value or vice versa. Your analogy is excellent when a stock (or market) is trending. If the price is trending up or down, value loses its importance. Trending up, buy regardless of value and trending down, sell regardless of value. This is the essence of momentum investing.

In spite of my critical comment, I love the uncertainty principle comment.

2008 Jul 13 09:45 AM

[Ames Tiedeman:]

I expect the DOW to be below 10,000 fast. Bad earnings and bad guidance cannot save this market.

2008 Jul 13 10:06 AM

[SW Richmond:]

Capitulation can occur rapidly or over quite a long period of time. In an unmanaged market, it could clearly be seen as an "event". But in today's managed markets, it will grind out over perhaps years. There will be many bottoms called. Look at the Nikkei from 1990 to 2000.

2008 Jul 13 11:51 AM

[Lilliana:]

Eventually everything in the panic will be dumped.
The market will be sold out. Fortunes are lost.
New money comes in from iron nerved investors.
Fabulous bargains abound..(Already)
The market inches up..on low volume.
The cycle goes on.. Fortunes are waiting to be made.
Read "John Train" Financial Times

2008 Jul 13 12:37 PM

[peterthepai...:]

this site is now posting much more realistic articles than earlier. comment makers of a bearish nature were given short srift when the penny had still to drop for some bullish traders.

2008 Jul 13 01:03 PM

[notsosmart:]

how often do you have to be hit on the head before you admit youare being hit on the head.some of these goldilocks heads are finally beginning to feel the bumps.in these times of greed & unethics you have to think for yourself.everyone has an agenda & lying isnt bad anymore.conservative socialism has crept into our system.a system that now has caused serious damage around the globe.of course it wont happen but the people who failed to stop this mess should be jailed.this is not free market its scam market.maybe the dumb-dumber american middleclass is finally waking up.maybe too late.

2008 Jul 13 02:58 PM

[OKMONEY:]

Best article I have seen on SA in a long time.

2008 Jul 13 03:15 PM

[d_galardi:]

Markos,

The last time the Hindenberg Omen fired was 11/7/2007.... where and how are you calculating the Hindenburg... Hindenbergs only fire when the market is at its top... not its bottom. Please explain how you are calculating it. Also I would suggest reading en excellent piece by the man who perfected it... Ian Woodward... www.highgrowthstock.co.... Browse through his blog.

We all are interested in your calculation... as there are time like June 6 where it was actually a false reading... keep in mind there are certain conditions for it to be valid.

Respectfully, David

2008 Jul 13 03:48 PM

[gemmanager:]

Yeah the middle class has awakened thirty years too late. This all started with Ronnie and his tax cuts to corporate america it inspired this new "greed". Free trade created a stressed middle class with stagnant wages while inflation escalated creating a new debtor society. Now comes the hangover Recession probably second only to the Great Depression. Wake up America you voted for these clowns who let Wall Street dictate how this country is run.

2008 Jul 13 10:47 PM

[late for di...:]

There is way to much speculation in all the markets. There are way too many people who used to work in factories doing day trading, running hedge funds, etc. They just mindlessly follow investment software signals and do not do investing. Trading is not investing. Pity all of us who try to invest for our own and our children's future. Hopefully we can take advantage of the big stock sale and not look at our loses.
The ETF is just another game for them to play.

Overtaxed in Sammamish

2008 Jul 14 01:27 AM