A Hindenburg Omen in an oversold market

Posted by Cam Hui -
Mid-week market update: What happens when an ominously sounding Hindenburg Omen occurs when the market is oversold? David Keller described the three components of the Hindenburg Omen in an article:
  1. The market has to be in an established uptrend;
  2. Market breadth becomes highly bifurcated, as measured by the expansion of new highs and new lows; and
  3. A downside break in price momentum.

Keller characterized the accuracy of this signal as “ten of the last three market corrections”. A single signal hasn’t been very useful, but a cluster of signals puts me on notice of a significant risk of a correction. The accompanying chart shows the history of Hindenburg Omens (pink=corrections, grey=false positives). Does the latest episode qualify as a cluster?

 

 

 

The limitations of the Hindenburg Omens

Here are some problems with the Omen. The Hindenburg Omen has been less effective when applied to the NASDAQ. Investors has seen a cluster of Omens during the latest advance and the NASDAQ 100 hasn’t corrected.

 

 

The current episode is characterized by a narrow advance led by a handful of stocks, while the rest of the market has exhibited weak breadth, which are the precisely sort of conditions the Hindenburg Omen is designed to capture.

 

 

What happens when the rest of the market is so weak that it’s already oversold? The accompanying chart shows the recent history of the S&P 500 when all three of the following indicators were oversold in unison:
  • NYSE McClellan Oscillator
  • 10 dma of S&P 500 % Advance-Declines
  • Percentage of S&P 500 above their 20 dma

 

Such conditions have been preludes of bounces of different magnitudes.

 

 

 

The FOMC decision

I rhetorically asked on the weekend if a hawkish cut would rattle markets. As expected, the Fed cut rates by a quarter-point today. The market came into the FOMC meeting expecting two more quarter-point cuts.

 

 

The Fed’s Summary of Economic Projections raised its inflation expectations and marked down its Fed Funds projections to be in line with market expectations of two quarter-point cuts in 2025, which is a dramatic change from the projections of four cuts in the SEP.

 

In reaction, bond yields rose, the USD rose, and stocks fell. The key question for equity investors is the degree of downside risk in light of the oversold condition of the broad market. Powell’s comments during the press conference sums up the market’s assessment of the future: “From here, it’s a new phase, and we’re going to be cautious about further cuts.” As a consequence, the market now expects only a single quarter-point cut in 2025.

 

 

I interpret these events as risk appetite panic is being overdone on the downside. The stock market is deeply oversold.  From a tactical perspective, four of the five components of my Bottom Spotting Model have flashed buy signals. In the past, two or more simultaneous buy signals have been good long entry points for traders.

 

 

Blood is running in the streets. It’s time to buy.