Mid-week market update: In case you missed it, the dreaded Hindenburg Omen has reared its ugly head again. In plain English, the Hindenburg Omen is signaled when a market with bifurcated breadth sees a rollover in price momentum. Single day signals tend not to be very useful, but clusters of signals may foreshadow future drawdowns.
As the accompanying chart shows, past Omen signals have been hit-and-miss. The latest cluster saw three consecutive signals in the last three days.
How should investors interpret the latest Omens?
The Bull Case
Here is the bull case for shrugging of the last Omens. A-D Line breadth remains positive and they are achieving new all-time highs. This is not bearish.
Here is an additional sign of the effects of positive breadth. Even as the S&P 500 struggles within a narrow trading range, the equal-weighted S&P 500 has staged an upside breakout to an all-time high. Outside the U.S., global non-U.S. stocks are in a health and well-defined uptrend.
Be aware that the bifurcated nature of the market can mainly be attributable to the weakness in software stocks. Even within the technology sector, semiconductor stocks are holding up well while software stocks are tanking.
As a consequence of software stock weakness, the NASDAQ 100 is deeply oversold, as measured by the percentage of stocks with 14-day RSI below 30. If history is any guide, these conditions have been preludes to price rebounds.
Other wildcards to consider are the upcoming earnings reports from Alphabet after the close today, and from Amazon tomorrow.
The Bear Case
Here is the case for caution. Beneath the surface, equity risk appetite indicators look a little shaky. The ratio of consumer discretionary to consumer staple stocks (green line) is exhibiting a negative divergence against the S&P 500. The ratio of high beta to low volaitlity stocks (red line) is tracing out a minor negative divergence.
The relative performance of IPO stocks have similarly cratered as animal spirit risk appetite has suddenly evaporated.
Investors should also be mindful of rising geopolitical tail-risk. The U.S.-Iran talks are expected to take place on Friday in Oman. Preliminary news reports indicate a mixed prognosis at best. Gulf states were supposed to attend as observers, but the latest reports indicate that they may not participate.
Iran wants to restrict the discussion to de-nuclearization. The American objectives of discussions of de-nuclearization, curbs on Iranian missile program, and curbs on support on regional militias seem to maximalist demands that are designed to torpedo the talks. In the meantime, not only have U.S. strike capability been built up in the region, the U.S. has been rushing THAAD and Patriot missile systems into the region, which is designed to defend allies against Iranian counter strikes.
The tail-risk is an all-out war which could only only spike oil prices, but elevate them for a considerable time. While this isn’t my base case scenario, the accompanying chart from John Authers shows the magnitude of an oil shock during the Iraqi invasion of Kuwait in 1990, which would crater global growth and spark an unexpected recession.
The current Polymarket odds of a U.S. attack on Iran by February 28 is 26%, which is significantly high to pay attention to. Keep in mind, however, the John Authers oil price surge scenario is an all-out regional conflict that may not develop even if an attack were to occur.
A Time for Caution
I resolve the bull and bear debate by concluding that this is a time for caution. For most of December and early January, my base case had been a tactical market top in late January and early February. I recently turned more bullish based on the sharp sentiment washout after the Greenland annexation scare, which opened the door to further gains (see
A Welcome Sentiment Reset). It’s time to walk back that initial bullish assessment and return to a more cautious view. I am not outright bearish, just more cautious. If you are max long, it may be time to take some profits at these levels.
The Hindenburg Omen signal provides a useful framework for the short-term outlook. A historical analysis of past Omen signals shows weak short-term forward returns, with average drawdowns at the -2% at the one-month horizon. That’s weak, but not catastrophic.
Companies that deal in bytes like software are falling since A.I. is causing them unknowable risks. Even the giant byte pushers like META, Microsoft and Google spending trillions are starting to warp minds as to how that can pay off. Until recently it was just giddy “We are changing the world!”. That is always a bubble ramps up. The reality hits with “How the hell do we make money with this.” Remember the weed stocks. They went up 2000% when the laws were changing and hype was rampant then fell 90% or more when sales of weed actually happened. OpenAI is bloody starting to sell ads to get some revenue. How much ad money is out there. Can consumers get urged to drink an extra Coke or two a day?
The atom pusher stocks are getting the buying as byte pushers are sold. These are the Value stocks that have real assets you can rap your knuckles on. They have real earnings. They have been ignored and are cheap.
There was a truly amazing 5% difference in return today between Growth and Value Factors. In one bloody day!!!. Value up big and Growth down big. Never saw that before.
Government deficit money printing keeps stocks floating higher. Investors don’t keep cash when they sell. They shift to another stock. The Hindenberg went down in flames as the hydrogen exploded. This is the opposite with just as many new atom pushing stocks hitting new highs and byte pushers hitting lows but the bubble balloon getting pumped up and going higher with hot Government money.
All fun and games until the bond vigilantes light up a celebration cigar in the dirigible lounge and BANG. No sign yet. Keep the champagne coming.