Has the Hindenburg Omen signalled a market top?

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We are pleased to welcome on board a new contributor – Ben Turney and here is his inaugural post.

On June 3rd my Google Alert for the “Hindenburg Omen” was triggered.  Since then I’ve received daily “Hindenburg Omen” updates as the technical indicator has continued to give signals and this has come to the attention of more market commentators . (An explanation of the Hindenburg Omen can be found here).

I originally set this Google Alert up in August 2010, when the Hindenburg Omen was last in the news. At the time, the warning of an imminent collapse given by this indicator was a big story and featured across many major financial publications and websites.  The Dow was then at about 10,000 and there was an expectation that the lows of early 2009 could well be retested. 

Of course they weren’t and the Dow has since powered forward, adding over 5,000 points.  How foolish advocates of the Hindenburg Omen looked.  After such a terrible read last time around, who in their right mind would trust this indicator today?

If the pieces I have been reading through my Google Alert are anything to go by, the answer to this question is not many.

But that could be a good contrarian indicator.  Major market movements seem to occur when the fewest number of people expect it.  And very few are predicting an imminent drop.

I accept that on its own the Hindenburg Omen is not that reliable a sell signal. It is estimated that significant stock market declines have only followed the indicator 25% of the time.  Even so, there have now been 5 Hindenburg Omens since May 31st. The last time such a concentration occurred was July 2007 and we all know what happened to markets over the following 18 months…

This time around, I am not expecting anything as catastrophic as what occurred from late 2007 to early 2009 but, I do think the analysis of many commentators has missed an extremely significant event the last time the Hindenburg Omen was triggered.  In late August 2010 Ben Bernanke gave this famous speech at Jackson Hole.  This set the scene for QE2 and sent stock markets flying again on the next leg of their liquidity fuelled surge.

It is no wonder that there wasn’t a general collapse as the Federal Reserve printing press went into overdrive.

Today the situation is completely different. 

The outlook for the latest QE programme is exactly the opposite of what it was in late summer 2010.  Then, a new round of QE was about to put the wind behind the sails of the market.  Now, the latest round of QE has been in full flow for 9 months and euphoric US Indices have powered to all time highs.  However, the debate is increasingly about when and how the Fed will bring QE3 to an end. 

The withdrawal of QE3 is likely to be a traumatic event for markets.  It has had such a pronounced effect that its removal will inevitably be challenging.  In fact, just the expectation of its removal could have a severe impact on stock prices. 

At the moment, there seems to be a growing consensus that the Fed will at least have announced its plans for ending QE3 by the end of this year, if not have actually started the process.  Exactly how this plays out is anyone’s guess, but it seems a pretty reasonable bet that this will not be positive for stocks.

In twelve months time, will we look back and laugh at the doom-mongering Hindenburg Omen or will hindsight tell us this was a good time to get out?

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