By Ben Turney
Yesterday, the Hindenburg Omen fired for the second time in a week. This is also the second time this summer that the signal has made its presence repeatedly within a short period of time, and is very reflective of general investor jitteriness about the health of US stocks.
Six weeks ago I wrote that a concentration of Hindenburg Omen signals could have suggested a significant top was forming in US stocks. Soon after, the benchmark American indices fell about 7-8%, only to recover quickly and then go on to make new highs. The initial shorting opportunity proved decent enough, though a large slug of the profit was wiped out as my trailing limits were hit. Sure, a profit is a profit, but, as I have said repeatedly recently, my current goal is take full advantage of a larger market move.
Strictly speaking, the rally from the end of June nullified the original cluster of Hindenburg Omens, as an indicator of a significant top at that point. Research has shown that the Hindenburg Omen requires confirmation within 40 trading days to be valid and, of course, we’ve seen new highs made in the last week. Automatically this means we should discount the previous occurrences in determining our next specific trading decision, but their presence could nevertheless still hint at a turning tide.
As unfortunate as the rally was to my plan to short US stocks, the move upwards has been one of treading water for the last three weeks. Markets have inched higher, but the differentials between open and close prices have been extremely tight and volume has been falling. Yesterday marked the US’s lowest volume level since December 2012. From a technical perspective, these points are usually associated with unhealthy market behaviour and could easily point to an imminent reversal.
In other words, the game may be up. My short position from before the FOMC position is still hanging in there and I am now looking to add to it.
I have been particularly conscious of the lack of volume over the last few weeks, although this is to be expected at this time of year, as many people are on holiday. The question has to be what will the major players do when they return?
Now that the Hindenburg Omen has fired twice within a week, I am going back to where I was just over a month ago. Although it has clear limitations as a technical indicator (research has shown it is accurate as little as 1 in 4 times), the Hindenburg Omen has however fired before every US stock market crash since 1985. Whether or not we are on the cusp of such a collapse is debatable, as there is little sign of systemic stress at the moment, but irrespective of this, the Hindenburg Omen still suggests increasing and widespread unease within a market.
In the context of the outlook for American QE this makes a great deal of sense.
The fundamental driver of this year’s surge in US stocks has undoubtedly been the bond purchasing programme the Federal Reserve initiated last September. It took a little while to get going, with the shocking handling of the Federal deficit, but since a deal was struck in the Senate in early January the market is up just over 20%.
The FOMC may have surprised many last week by not making official mention of its plans to start tapering, but improving economic data continues to suggest this is on the cards this year, not least with today’s trade figures. No one really knows how US stocks will cope with the withdrawal symptoms, but even a gradual reduction could have a severely detrimental effect.
Perhaps this is exactly what the Hindenburg Omen is warning us of?
***NOTE – The Hindenburg Omen is fairly complex to calculate. The simplest way to keep track of it is to set up a Google Alert. This has worked well for me.