August 19th, 2013
by Albertarocks, Albertarocks TA Discussions
The Hindenburg Omen has put forth one of the strongest signals in its history, as judged by the tightest cluster of signals ever produced... as far as I know. Let's put it this way, with 6 signals in 8 trading days who's going to quibble? That's a strong enough warning for anybody who is at least half lucid.
Consider this... if you and your lovely family were out sailing on the Gulf of Oman some beautiful Saturday afternoon in your 42 footer, and the Iranian navy fired a 6-pounder across your bow, you know darned well you'd take notice.
The prudent sailor might even take the hint and reverse course. But naturally there are always the few heroes who might be considered as... what's the best word... daft... the ones who would wait for a second volley just to be sure. Not a smart choice in my opinion. Not when taking cannon fire. And especially not when the HO is firing the volleys. For, he who dares hold his course even after 6 rounds have whizzed past his nose, each successive shot being closer than the last... well, unless course is changed, the odds are high that sailor's ship is surely destined to take a big direct hit.
However, historically the number of warning signals in a cluster (within the 36-day window for which a signal remains in effect) has no correlation to the size of the following market adjustment. In fact the reactions of the market following a HO signal is quite variable and a disaster is far from an assured thing. This I have documented previously:
Major Crash - 27% probability
Selling panic of at least 10-15% - 39% probability
Sharp decline of at least 8-10% - 54% probability
Meaningful decline of at least 5-8% - 77% probability
Mild decline of at least 2-5% - 92% probability
The HO signal is an outright miss - 7.7% probability (one out of 13 times)
But one of my readers has sent me a very neat piece of work which asks a question I had not been alert enough to consider: Does the recent market behavior before the HO is delivered have any correlation to what happens afterwards? Specifically, the reader ( an old friend from Tasmania) asked the following question:
"Does the steepness of the rally prior to a confirmed Hindenburg event offer any predictive value?"
He not only asked the question, he also delivered the analysis which gave the answer. Now that is a real friend.
Here is a summary of the analysis with my (AR) added notes and emphasis. The Tasmanian analyst goes by the internet handle "Wave Rider".
His basis: "I have always been interested that the number of sightings of the HO in a cluster does not seem to be a predictor of the strength or timing of any subsequent downturn. I have therefore been spending some time on the keyboard examining all the data associated with the recorded confirmed HO's going back to 1986."
His qualifiers: "Rather than use the DJIA that Dr. Robert McHugh used, I have used the S&P as it probably gives a better indication of the wider market. You still get the same approximate proportions of declines that are regularly quoted for the HO. i.e. 25% of the time the market falls by 15% or more, etc."
His general observation: "The interesting thing though, is that while the number of sightings in a cluster is no real guide to the dimension of any decline, the pace of the rising market before a confirmed HO is. Generally, the majority of confirmed HO with subsequent major declines have come after the market has averaged a gain of over 0.08% per day since the low that followed the previous HO. How long ago the last HO occurred does not seem to affect this observation."
The data he uncovered: "The results of the HO which followed daily gains averaging over 0.08% were -31%, -30%,-21%,-18%, -15%, -10%, -5%, -3% and 0%. That's 6 out of the 8 declines of 10% or more. By comparison, in the case of all other confirmed HO where the average daily rise of the market was less than 0.08% the average decline after a HO averaged less than 7%. And that was only brought up that high by a couple of outrider observations."
Wave Rider's Conclusion: "The interesting thing about the cluster of HO you are currently recording is that the average daily gain since the market low following the last confirmed HO is the second highest on record. That assumes the May/June HO is considered a different one to the August one we are currently monitoring (AR's note: Correct assumption). This suggests the present HO could be a portent for a very significant market decline indeed."
An additional point: Hence the rule "The faster they rise the further they might fall". Incidentally, the average daily growth rate before the August 5, 2013 HO was 0.193%. That is by far the highest ever, except the doubtful Dec 1998 HO."
[AR: Good lord, I hope readers appreciate the implications of that last "additional point".]
I would recommend that the HO never be ignored but the amount of diligence in following the market should greater at some times than at others. Based on Wave Rider's fine work, this time would seem to be one for heightened alert status.
So while we ponder this brilliant insight, let's imagine how Wave Rider must be celebrating his great analysis. Perhaps getting away from the hectic market as in the picture below.