Weekend Market Analysis

(12/14/13)

Another Hindenburg Omen (HO) occurred this week which is the third instance since June.  I use the following criteria to define an (HO).

1. The daily number of NYSE new 52 week highs and the daily number of new 52 week lows are both greater than or equal to 2.5 percent of the number of issues traded that day (some use 2.2% or 2.8%).
2.  The NYSE Index is greater in value than it was 50 trading days ago (some use a 10 Week Moving Average).
3.  The McClellan Oscillator is negative on the same day.
4.  New 52 week highs cannot be more than twice the new 52 week lows (although new 52 week lows may be more than double new highs).
5.  Two Signals must occur within a period of 30 Trading Days (some use only one signal to confirm a Hindenburg Omen).

Keep in mind we can only calculate Hindenburg Omen Signals back to 1980 since the NYSE calculated New Highs and Lows differently prior to 1980.   After 1980 New Highs and Lows were based over a 52 Week Rolling Period while prior to 1980 New Highs and Lows were not based on a 52 Week Rolling Period. 

Meanwhile one key aspect that is ignored by investors when dealing with Hindenburg Omen's is whether the market is overvalued or not.   When you factor in these two additional parameters (Shiller's PE Ratio is at least "18" the prior month and the S&P 500 is 100% or more above its 5 Year Low) then the number of signals is reduced to the following time periods:  September 1987, December 1999, October 2000, July 2007, October 2007, June 2013, August 2013 and now December 2013.

As you can see since 1980 there have only been "8" HO Signals when the Shiller PE Ratio was above 18 and the S&P 500 was at least 100% above its 5 Year Low so it has been a rare occurrence.   The prior HO Signals in 2007, 2000/1999 and 1987 were followed by substantial corrections ranging from 36% to as high as 58%.   Overall we have seen "3" Signals since June but so far a decent correction hasn't developed.  

If the recent HO Events do eventually lead to another substantial correction there are a couple of scenario's to watch for.  Since the end of World War 2 the S&P has held long term support at its 200 Month EMA (points A), 400 Month EMA (points B) or longer term upward trend line (dashed purple line) connecting the 1932 low with the 1942 low.  Furthermore as you can see there have only been two occurrences when the S&P has actually dropped below its 200 Month EMA during the past 70 years (2009 and 1974).  

For theoretical purposes let's say the recent high of 1813 was a top.  Currently the 200 Month EMA is in the mid 1150's while the 400 Month EMA is in the upper 800's.  Thus if a larger correction were to develop a drop back to the mid 1150's would be a 37% correction while a move down to the mid 800's would be a 51% correction.  Meanwhile the worst case scenario would be for a retest of the longer term upward trend line (purple) which would be near the previous low made in 2009 at 667.  This would be a 63% correction if it occurred.  

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