The darker meaning of the Hindenburg Omen

Posted by Cam Hui -
Preface: Explaining our market timing models

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

 

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

 

 

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

 

 

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
  • Trend Model signal: Neutral (Last changed from “bullish” on 15-Nov-2024)
  • Trading model: Bullish (Last changed from “neutral” on 19-Dec-2024)*

Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent and on BlueSky at @humblestudent.bsky.social. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.
 

Subscribers can access the latest signal in real time here.

 

 

An unusual omen

I recently highlighted the trigger of the ominously named Hindenburg Omen, which describes the condition of a highly bifurcated market undergoing a downside break (see A Hindenburg Omen in an Oversold Market). While Hindenburg Omens often resolve in corrective market action, the current episode occurred against the backdrop of an extremely oversold market with readings reminiscent of the Christmas Eve Panic of 2018, the COVD Crash of 2020, and the October bottom of 2022.
 

 

 

 

A tactical buy signal

Indeed, four of the five components of my Bottom Spotting Model triggered buy signals. In the past, two or more buy signals have resolved in near-term bottoms and relief rallies.
 

 

The tactical buy signal was confirmed by Rob Hanna of Quantifiable Edges, who revealed a buy signal on his Capitulative Breadth Indicator.
 

 

The stock market is poised for a significant relief rally.
 

 

Not out of the woods

Nevertheless, market internals are marred by a problem of poor breadth. Even the bounce has been led by large-cap growth stocks, and the rest of the market isn’t showing much enthusiasm.
 

 

Jason Goepfert of SentimenTrader found the current conditions disturbing. He studied cases when the “S&P 500 is within spitting distance of a high yet fewer than 39% of its stocks are even above their 50-day moving averages”. The closest template he found was in 1972, when the market staged a relief rally, but topped out a few months later, which turned out to be the top of the Nifty Fifty era.
 

 

The 1972 template represents the dark side of the Hindenburg Omen.
 

 

What to watch

Will history repeat itself? Will it rhyme?

 

Here is what to keep an eye on. Breadth has been deteriorating, which is a worrisome development. All Advance-Decline Lines have broken down below their 50 dma. Can they recover back to their highs when the inevitable relief rally appears?
 

 

Negative A-D Line divergences are nothing to worry about in the short run. However, they can be warnings of long-term cyclical tops. In the past, A-D Line divergences have persisted for months before the S&P 500 made the ultimate top.
 

 

Another sign to watch for is a negative RSI divergence in my long-term timing model based on the monthly chart of the NYSE Composite. Watch for a negative 14- month RSI divergence should the index make a new high.
 

 

In the short run, I am tactically bullish. In addition to the buy signals triggered by my Bottom Spotting Model, the relative performance of defensive sectors is not showing any leadership, which is an indication that the bears haven’t seized control of the tape.
 

 

I would also monitor the relative performance of small cap stocks. The Russell 2000 halted its decline at relative support (bottom panel). A small cap revival during this seasonally positive period would be tactically bullish and could serve to alleviate some of the breadth concerns about a potential long-term market top.
 

 

In conclusion, current market conditions are characterized by a strong S&P 500 that’s near its all-time high and weak breadth. The closest template to these circumstances is August 1972, which is just before the final Nifty Fifty top. As the market undergoes its inevitable bounce due to oversold conditions, investors should monitor technical conditions for negative divergences, which could be the signal for a long-term cyclical top.

 

Subscribers received an alert on Thursday that my inner trader had initiated a long S&P 500 position. The usual disclaimers apply to my trading positions.

I would like to add a note about the disclosure of my trading account after discussions with some readers. I disclose the direction of my trading exposure to indicate any potential conflicts. I use leveraged ETFs because the account is a tax-deferred account that does not allow margin trading and my degree of exposure is a relatively small percentage of the account. It emphatically does not represent an endorsement that you should follow my use of these products to trade their own account. Leverage ETFs have a known decay problem that don’t make the suitable for anything other than short-term trading. You have to determine and be responsible for your own risk tolerance and pain thresholds. Your own mileage will and should vary.

 

 

Disclosure: Long SPXL