Hindenburg Omen: Imminent Warning Or Just Hot Air?
Chris Puplava | Aug 15, 2013 12:19AM ET
The ominously named Hindenburg Omen has been The Warning Signs of Major Market Tops ” by Paul Desmond (12/01/2012). Free copy available upon request.
As Mr. Desmond points out, at major market peaks you see plenty of stocks hitting new 52-week lows even as the market is hitting new highs, a point that characterizes the Hindenburg Omen and why it can be useful in avoiding market losses. However, I believe that the Hindenburg Omen has lost some of its usefulness given the number of non-operating companies that are now so prevalent on the NYSE. The NYSE now has a considerable number of closed-end bond funds that trade on the exchange, which cloud the data for 52-week highs and lows, as I'll explain below.
During economic expansions, interest rates begin to rise as the economy picks up steam. This occurs as bond investors anticipate higher economic growth rates typically associated with higher rates of inflation. Thus, you can see stocks rally while bonds sell off. With this backdrop you see stocks hitting new 52-week highs while bonds funds hit 52-week lows.
Therefore, looking at the number of securities hitting new highs and lows would be deceiving. Conversely, in the midst of a bear market when investors are pouring into safe assets like bonds and driving interest rates lower and bond prices higher, the NYSE new highs list would be dominated by bond funds and the new lows would be dominated by operating companies (stocks). For this reason I believe that looking at only the number of new issues making 52-week highs and lows is deceiving and why the Hindenburg Omen may have lost some of its relevance.
With that said, it would be unwise to dismiss all Hindenburg Omens outright as they have correctly called prior market tops. This can be seen during the last bull market as we got a cluster of them just as the market was peaking during the July 2007 peak and the October peak as seen below.
What I want readers to hone in on though are the spikes in new highs and lows in the bottom panel. Notice we got a cluster of Hindenburg Omens in late 2005 and yet we only saw a mild pullback—not a crash or bear market, which was confirmed by new highs still dominating new lows, as seen in the lower panel. However, around the cluster of Hindenburg Omens in 2007 we saw that new 52-week lows began to dominate new highs; this was the sign of a market topping and why the Hindenburg Omen carried more weight in 2007 than in 2005.
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We saw a few Hindenburg Omens in May and yet the market powered to new highs that month, but we are getting a cluster of Hindenburg Omens again and investors are getting jittery. For example, Tuesday (08/13/13) there were 349 new 52-week highs on US exchanges, while there were 282 new 52-week lows, thus giving a Hindenburg signal. However, delving into the details paints a far from worrying picture and suggests investors should not be running for the hills.
Looking at the new highs data we see that of the 336 issues that hit new highs, 96% of them were common stocks while closed-end funds, REITs, and MLPs comprised the remaining.
Then, if we look at market cap, 55% were more than $1B in size and 80% were at least $100M.
Looking at new lows paints a very different picture. There were 282 new lows but only 54% of them were common stocks and 40% of them were closed-end funds and of the 112 closed-end funds, 109 were fixed-income focused and 94 were focused on munis. Taking the 39% fixed-income focused closed-end funds and the 5% of REITS and 1% MLP show that 45% of the total new lows were based on interest-rate sensitive securities which likely reflect the rise in interest rates within the context of an accelerating economy.
Moreover, looking at the market cap of the new lows is very different than the makeup of the new highs. While 80% of the new highs were greater than $100M in size, only 13% of the new lows had a market cap greater than $100M with 79% below $50M.
So, while the new 52-week highs and lows were relatively close in number, their makeup was very different as new highs were dominated by larger cap operating-only companies while new lows were dominated by fixed-income closed-end funds and very small companies.
Additionally, I do not believe the May cluster nor the present cluster of Hindenburg Omens will prove to characterize a market top as new 52-week highs continue to dominate new lows (green shaded box) completely, unlike what we saw in 2007 (see chart above).
Rather than look at the NYSE I wanted to see how looking at operating-only company data appeared and so as to not place a greater weight on large cap stocks I used the S&P 1500, which is composed of 600 small cap, 400 mid cap, and 500 large cap stocks with a sample size just under half of the NYSE.
Tuesday we saw 118 new 52-week highs on the S&P 1500 (7.9% of total issues) and only 7 new lows (5 were REITS) or 0.5%; and so there would not have been a Hindenburg Omen on the S&P 1500 Tuesday. What is more encouraging is that of the 118 new highs, 76% were cyclicals and 7% were commodity-focused, while defensive non-cyclical stocks made up only 17% of the total. So for every stock hitting a new 52-week low on the S&P 1500 you had nearly 17 hitting a new high and 83% of those that were hitting new highs are economically-sensitive stocks.
Sector Breakdown of Stocks hitting 52-Week Highs in S&P 1500 (as of 08/13/13)
A visual inspection of the number of S&P 1500 stocks hitting new 52-week highs versus lows shows an incredibly healthy market that is dominated by the bulls as the number of new lows is barely visible relative to new highs. This is not what one would expect if the market was in the process of topping and in which the bulls and bears were in equal size.
Summary:
While I would never dismiss a Hindenburg Omen outright, it does make more sense, I believe, to run the criteria on operating-only companies like the S&P 1500 rather than on the NYSE, which is riddled with closed-end bond funds. While we are getting Hindenburg Omens on the NYSE like we did during May, the spike in new lows is largely due to fixed-income (interest-rate sensitive) funds, which I believe are selling off due to a strengthening economy. This makes perfect sense when you run the criteria for the Hindenburg Omen on the S&P 1500, which is nowhere remotely near a "sell signal", given its composition of companies linked to economic growth. That said, I do anticipate we could have some weakness heading into the September FOMC meeting but do not anticipate any major decline as those referencing the Hindenburg Omen suggest.
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