Friday, May 31, 2013

The Hindenburg Omen Meets the Bond Bubble

Jonathan Krinsky, a technical analyst at Miller Tabak has spotted the Hindenburg Omen in  stock market activity this week, reports Joe Weisenthal. I have written about the Hindenburg Omen before:
So is the Hindenburg Omen the real thing or hocus pocus? First to the negative, it appears that the discoverer of HO appears to have just run various empirical data back tests. As far as I am concerned, it is  not very impressive to find an indicator via back testing and just running with it. In fact, empirical testing as an investing method generally results in investments that blow up, see Long Term Capital Management and subprime mortgages. That said, I am never against looking at a formula to see if it can be understood in terms of human action, to indeed see if it can show some promise as a solid indicator. So let's take a look at how HO is determined:

The 5 Criteria that Must be Triggered for an HO moment to be considered activated:

1.The daily number of NYSE new 52 Week Highs and the daily number of new 52 Week Lows must both be greater than 2.2 percent of total NYSE issues traded that day.

2. The smaller of these numbers is greater than or equal to 69 (68.772 is 2.2% of 3126). This is not a rule but more like a checksum. This condition is a function of the 2.2% of the total issues.

3.That the NYSE 10 Week moving average is rising.

4.That the McClellan Oscillator ( a market breadth indicator used to evaluate the rate of money entering or leaving the market and interpretively indicate overbought or oversold conditions of the market)is negative on that same day.

5.That new 52 Week Highs cannot be more than twice the new 52 Week Lows (however it is fine for new 52 Week Lows to be more than double new 52 Week Highs).
I like the #1 factor in the formula. If you have strong activity at both ends, highs and lows, to me this shows as a shifting market, with cross trends--a very good sign of an unstable market.

#2 is a checksum, so nothing to comment about here.

#3 A moving 10 week average indicates the market is high enough for a drop. Obviously, stocks are more likely to fall from high levels than low levels.

#4 This is interesting. The McClellan Oscillator measures cash flow in and out of the market. So if you a negative MO (cash flowing out) but stocks up on a 10 week average, things are getting intense. Stocks higher on less cash is always negative to me as it indicates money is running out to support an advance.

#5 This is also interesting, since in #1 we are detecting movement at both ends. Here we are insuring that a significant part of that new high/new low action is to the downside relative to new highs.

Bottom line: I like this indicator. I wouldn't bet my house on just this indicator, but if you have slowed money supply growth and this indicator kicks in, things get interesting, since this indicator is really telling you there is significant enough upside action for a major drop, but at the same time something is already causing downside action in other stocks plus cash is leaving the market.
Here's the current situation as reported by Krinsky:
 The Theory then goes like this: 
Two such signals within a 36-day period is consider ed a Hindenburg Omen. The Hindenburg Omen portends a serious decline within the next 40 days . (note: the 36 day period is somewhat ambiguous, as we have seen some say it is a 30 day period, and some say it must be 30 calendar vs. 30 business days). 
Let’s look at the first “observation” that occurred on April 15 th of this year.
1) NYSE New 52 Week Highs = 70 , New Lows = 77 . Both exceeded 2.2% of total issues that day.
2) The 10 Week (50 Day) Moving Average Was Rising
3) The McClellan Oscillator was negative
4) New 52 Week highs were NOT more than twice 52 week Lows  
All 4 criteria were met.
Now on Wednesday, May 29 th , we got a second “observation”, which creates the confirmation of the Omen.  
1) NYSE New Highs = 58 , New Lows = 104 . Both exceeded 2.2% of total issues that day
2) The 10 Week (50 Day) Moving Average Was Rising
3) The McClellan Oscillator was negative
4) New 52 Week highs were NOT more than twice 52 week Lows

Currently, as I have been reporting in the EPJ Daily Alert, money growth is far off its highs.This falls in line with the Hindenburg Omen observation, which is indicating that money flow into the stock market is slowing. But further, I have been pointing out in the EPJ Daily Alert that when the stock market and bond market both start moving to the downside at the same time, it will be a dangerous sign. For most of the current stock market bull move, bonds have been trading down while stocks have been heading higher, that is, there has been a flight away from the perceived "safety" of the bond market and into the stock market.  

If the stock market heads down AND the bond market heads down that is a sign there is less money in the system. The stock market AND bond market both closed down today. This is just one day of activity, but it is an important signal of possibly money drain from the system.

The bond market bubble appears on the edge of exploding. Bond interest rates have been raggedly moving up since mid-2012.

 If the bubble explodes and the bond market heads down with intensity, this won't be good for the stock market. It truly will be the Hidenburg Omen meeting the Bond Bubble. It won't be pretty.

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