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OVER THE PAST WEEK, the amount of media coverage given to a rather obscure conglomeration of technical signals called "The Hindenburg Omen" has been extensive. As its menacing name suggests, it is supposed to be a very bad sign for the stock market.
I do agree that there are multiple bearish warnings from many areas in the stock market. But panicking from a specific list of individual technical events is not one of them — at least not yet.
Without rehashing the nitty-gritty details, the Omen looks for a rising market where the number of new 52-week highs and new 52-week lows each reach a specific threshold. The idea is that such a condition is inherently unstable. And in the stock market, instability rarely leads to rallies. The word "crash" is frequently found in the Hindenburg Omen's forecast.
Rather than dwell on the individual component conditions, let's concentrate on the meaning of the grouping. I call it the "spirit of the analysis" rather than the "letter of the law," the latter being a static checklist of indicator values.
The spirit is what any technical indicator is supposed to capture. We can slice and dice any chart into such fine pieces that we can literally make it say whatever we want. Analysts call it "data mining." They can adjust the criteria for any signal to make it fit the data and create a beautiful indicator to predict the past.
For the Hindenburg Omen, the idea is to flag seemingly bullish market conditions that are hiding a fractured underbelly. One major component of the Omen requires that more than 2.2% to 2.8% of all stocks on the New York Stock Exchange reach new highs at the same time that a similar number or more reach new lows.
That condition, or at least one that was close, occurred last week. But there are other bearish splits in the stock market, including a divergence between stocks with large and small market capitalizations. Traditional leading sectors in bull markets, such as technology and financials, are lagging the rest for another negative divide.
Even reactions to good earnings reports have been muted at best. The psychology of the market is now one of disappointment, and that does lead to sensational headlines on the bearish side.
What is more sensational than comparing the stock market to a 1930s dirigible that went down in flames?
But again, does the Hindenburg signal mean the market is doomed, as well? For starters, analysts cannot agree that it fired at all last week (see Chart 1). Some data services reported the required numbers of highs and lows and others did not. Some meddled with the composition of NYSE-traded issues, considering only operating companies and throwing out exchange-traded funds (ETFs) and bond-related instruments. I have even seen reports that could not even agree on which day last week the signal fired.
Chart 1
The point is that mechanically following such a specific set of rules can often lead to action that does not match the spirit of the market. This is when we have to look at the big picture.
For example, stocks are now in the weak part of their annual, or seasonal, cycle. With September and its record of being the only month to post an average loss over the decades, it would seem that the environment is unfavorable for stocks.
Another important cycle is the four-year presidential election cycle. This analysis suggests a major low is due in October of this year.
Finally, with the bond market soaring and so-called risk assets including crude oil floundering, there is also an argument from other markets that stocks are fighting strong headwinds.
So what do we do with last week's arguable Hindenburg Omen? Given the intense interest it has garnered and the scary images portrayed in the media, it would be tempting to dismiss it. After all, if the majority of people are bearish thanks to the Omen, it might be a contrarian signal to buy.
While I believe that there is no reason to panic yet, I leave the door open for a reason to flee equities later. A single Hindenburg Omen signal may be a warning that something is not quite right, but when the signals start to cluster, meaning several within a few weeks' time, the track record gets a bit better. Such was the case at the 2007 market top.
Signal or not, with all the other technical evidence now on the table, it does look like a good time to play defense. A cluster of Omens would just make the bearish case stronger.
Getting Technical Mailbag:Send your questions on technical analysis to us at online.editors@barrons.com. We'll cover as many as we can, but please remember that we cannot give investment advice.
Michael Kahn, mutual fund co-manager, author of three books on technical analysis, former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, also blogs at www.quicktakespro.com/blog.
Comments? E-mail us at online.editors@barrons.com
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