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The Hindenburg Omen

I've seen a number of articles recently discussing the so-called "Hindenburg Omen." I ignored them until today because I don't think it's a relevant issue at all. But I've received some reader requests to discuss it, so I'm doing so now.

Mark Hulbert provides the following snapshot of this indicator:

The core idea behind the Hindenburg Omen is that it's bearish whenever there are a large number of both new 52-weeks highs and new 52-week lows on the NYSE.

If we trace the Omen's genealogy even further back, however, we find that it is a direct descendant of an indicator called the High Low Logic Index, which Norman Fosback, editor of Fosback's Fund Forecaster, devised in the 1970s.

In his classic textbook Stock Market Logic, Fosback explained why a large number of both new highs and new lows is bearish: "Under normal conditions, either a substantial number of stocks establish new annual highs or a large number set new lows — but not both.... [When both nevertheless occur], it indicates that the market is undergoing a period of extreme divergence.... Such divergence is not usually conducive to future rising stock prices."

The trouble is that for this Hindenburg Omen, even when properly computed (more on that in a moment) it has a pretty stinky predictive record. Here's Barry Ritholtz's withering response to a recent Wall Street Journal article on the subject:

Now, I'm open to all manner of data analysis. But when you tell me (toward the end of your story) that (emphasis mine): "The Omen was behind every market crash since 1987, but also has occurred many other times without an ensuing significant downturn. Market analysts said only about 25% of Omen appearances have led to stock-market declines that can be considered crashes," you have pretty much wasted my time. Wake me up when you find something with an actual correlation — last I checked, 25% isn't even in coin-flip territory.

Jumping back to Hulbert, he brings up the very valid point that this indicator may not have even triggered under its traditional definition. Originally the threshold for new highs/lows was 5%, then it got reduced to 2.5% (you can read his full article for the details, if you're interested). But there are so many issues that trade on the NY stock exchange now that aren't even operating companies (think closed-end mutual funds, preferred stocks, etc.), there's a real question about the data the current Hindenburg alarmists are citing:

According to Ned Davis Research, the institutional research firm, a Hindenburg Omen would not have been triggered if analysts were to focus just on common stocks. On Aug. 12, for example, the day that this Omen was supposedly triggered, just 0.4% of common stocks on the NYSE hit new 52-week highs, according to the firm.

To summarize, there are plenty of things to be legitimately concerned about in the current economic/market picture. The Hindenburg Omen is not one of them.

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