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Weekend Stock Market Analysis

(7/28/12)

Although the market rallied strongly Thursday and Friday in anticipation of QE 3 being announced next week by the Federal Reserve we have a dangerous market environment in place.    This week the criteria for a Hindenburg Omen occurred based on the old methodology however some have adjusted the rules to limit the number of false signals.  

I use the following criteria to justify a signal:

1.  The Number of new 52 Week Highs and Lows much be at least 2.5% of the number of issues traded on the NYSE.
2.  The number of new 52 Week Highs must not be more than twice the number of new 52 Week Lows.
3.  The McClellan Oscillator must be negative.
4.  The NYSE 10 Week Moving Average must be rising.

Also there must be a second occurrence of the above mentioned criteria to get a confirmed Hindenburg Omen Signal within 30 trading days.   Furthermore if we add a few additional rules shown below this narrows down the number of actual occurrences to 11 since the mid 1960's.

5.  Shiller's PE Ratio is above 16
6.  The S&P 500 must be above its 10 Month Moving Average.

The chart below shows Shiller's PE Ratio (red) vs the S&P 500 (blue) along with the confirmed Hindenburg Omens (purple squares).   As you can see confirmed Hindenburg Omen Signals occurred near the 2007 Top, 2000 Top, the 1987 Crash, the early 1970's Top, 1969 Top and the 1966 Top.   

Meanwhile the table below gives a more detailed look at each confirmed Hindenburg Omen going back to the mid 1960's.   The only events that weren't followed by a significant top were in April of 2006, May of 1971 and October of 1967, however, even these signals were followed by corrections ranging from 8% to 13%. 

Signal	Peak	Peak	Low	Low	%
Date	Date	Price	Date	Price	Correction
7/24/2012	?	?	?	?	?
10/18/2007	Oct-07	1576	Mar-09	667	-57.6	Major Top...S&P falls 58%
7/11/2007	Jul-07	1556	Aug-07	1371	-11.9	Precedes Major Top by 3 Months
4/17/2006	May-06	1327	Jun-06	1219	-8.1	Minor Correction
12/6/1999	Dec-99	1476	Feb-00	1325	-10.2	Precedes Major Top by 3 Months...S&P falls 50%
9/24/1987	Sep-87	322	Oct-87	216	-32.9	S&P drops 36% in 9 Weeks
3/23/1972	May-72	111	Jul-72	106	-4.5	Precedes late 1972 Top...S&P falls 48%
5/17/1971	May-71	104	Nov-71	90	-13.5	Minor Correction
5/26/1969	May-69	106	May-70	69	-34.9	Major Top...S&P falls 35%
10/13/1967	Oct-67	98	Mar-68	88	-10.2	Minor Correction
2/1/1966	Feb-66	94	Oct-66	73	-22.3	Major Top...S&P falls 22%

Thus as mentioned in the beginning this is a dangerous market environment and investors should pay close attention to their long term positions and not let things get out of hand.   CMG provides an excellent example of how fast things can change as stocks typically go down a lot faster than they go up.  

Also there is no guarantee that a stock will recover once it begins to sell off.   Just ask the folks who bought RMBS back in 1999 and 2000.  Notice it's still near all time lows a decade later.

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