The Hindenburg Omen

There was a major blip on most traders radar screens this weekend in that a Hindenburg Omen observation occurred last Thursday, August 12th. The financial blogosphere was lit up with articles and posts about the occurrence, but if you want a detailed account of what I consider to be the best article on the subject, go no further than Robert McHugh's "The Recent Hindenburg Omen Observation" at http://www.safehaven.com/. In order not to poach too much of Mr. McHugh's material, I'll keep my descriptions brief and liberally quote him, so here goes his explanation of what exactly is a Hindenburg Omen: "It is the alignment of several technical factors that measure the underlying condition of the stock market - specifically the NYSE - such that the probability that a stock market crash occurs is higher than normal, and that the probability of a severe decline is quite high."

According to Wikipedia, the criteria for a Hindenburg Omen: "...are calculated daily using Wall Street Journal figures for consistency.". The criteria are: "1)The daily number of NYSE new 52 Week Highs and the daily number of new 52 Week Lows are both greater than 2.2 percent of total NYSE issues traded that day. Based on approximately 3100 NYSE issues, the 2.2% threshold is 69. 2) The NYSE 10 Week moving average is rising. 3) The McClellan Oscillator is negative on the same day. 4) New 52 Week Highs cannot be more than twice the new 52 Week Lows (though new 52 Week Lows may be more than double new highs).".

How high of a probability is there that a crash will happen? First, there has to be more than one Hindenburg Omen occurrence in 36 days for there to be considered a real possibility of a retreat in the market, swiftly or gradually. But if there is, McHugh points out: "there is a 30 percent probability that a stock market crash - the big one - will occur if we get a confirmed (more than one in a cluster) Hindenburg Omen. There is a 40.8 percent probability that at least a panic sell-off will occur. There is a 55.6 percent probability that a sharp decline greater than 8% will occur and there is a 77.8 percent probability that a stock market decline of at least 5% will occur. Only one out of roughly 13 times will this signal fail."

Both The Wall Street Journal and Art Cashin on CNBC had pieces on the Hindenburg Omen this week, so it's not really a far flung notion that a few lunatic fringe traders are drumming up on bulletin boards at the major financial Web sites. As Cashin stated on Monday, "We've never had a heavy sell-off without a Hindenburg Omen, but we've had Hindenburg Omen's without a sell-off.". With this August being a particularly light on volume, even for August when most professional traders are vacationing, it's difficult to tell what will happen, but it does signal caution because market internals are deteriorating. I won't have to keep too close of an eye on this because if we do get a confirmed Hindenburg Omen, it will be all over the financial blogoshpere, not to mentioned the mainstream financial press. This could be another catalyst for the downturn I've been looking for that will surely turbo charge my portfolio.

Swinging for the Fences

If you've been following this blog, you're aware that I expect a major correction, if not a market meltdown, and feel my short positions will make for lucrative investments in the next year or two. On a personal note, most of my money is in cash right now, sitting in CD's which aren't earning too much interest, to take advantage of what I perceive to be a once in an eon market implosion that we haven't seen the likes of since the 1930's. The Ithaca Experiment Portfolio is exactly that, an experiment, but it is my own real money I'm tracking, and I could conceivably make a killing not only shorting the market to the downside, but playing the bounce on the way back up.

Market sentiment still remains bullish in many camps and not only do my short positions seem foolhardy from that perspective, but so do my cash positions if you're from that ilk. I keep hearing phrases from the guests on CNBC like: "You can't make any money by being in cash and bonds are overvalued so your best bet is to be in stocks.". Sure bonds may be overvalued but, I couldn't disagree more with the stances on cash and securities. If the market declines again, either in a slow and grinding rewind or by cascading downward off a cliff caused by high-frequency trading, being in cash would be your best bet because of preservation of capital.

The Great Recession is not over yet. In the August 7th issue of The Economist in an article entitled A Deeper Hole, the author states that "the recession was even worse than everybody thought" based on data revisions by the Commerce Department. The article goes on to say that: "These changes confirm the recession as the worst of the post-war years.". To give a historical perspective, the post-war years do not mean since the end of Desert Storm, but the end of The Big One, World War II. Sure, the Market lost considerable ground from late Summer 2008 to March of 2009, but that was only for a few months. Do you really think the worst financial calamity since the 1930's would be over in a blink of an eye? It has only been two years since the Fall of 2008, and if the 1930's or 1970's are any indication of what's to come next, we've only got more volatility to go. The trend is flat or to the downside.

I believe that many of the bullish analysts are too myopic in their assessments of the market with time horizons that go back only 20 or 30 years. Despite the crashes in the market from 1982 to 2008, you made damned good money by being fully invested in S&P 500 or DOW index funds with a buy and hold investing strategy. The NASDAQ is a different story, but you get my drift. Those days are over.

Let's not forget that the FED came out last week and stated the economy would be under pressure for the second half of 2010. That, coupled with bellwether global technology firms Cisco (CSCO) and IBM (IBM) saying that growth would be muted going forward for at least two quarters gives one time to pause. Who do you believe, the majority of CEO's that are giving rosy earnings estimates going forward? They have nothing to gain by being negative on the market becuse they are judged by the price of their stocks. Cisco CEO John Chambers is a straight shooter and has a track record making market predictions based on his perceptions of where the market is going by checking his channels of his well oiled machine. I listen to what he has to say very carefully. So for the mean time, it's steady as she goes.

The Opening Act

Since my last posting in late May, the DOW is up roughly a meager 250 points. If you are a buy and hold investor, you made a little money. If you traded the volatility, and traded it right, you could have picked up a substantial amount of coin. However, we all know that timing the market is a dangerous game and rarely do your profits coincide with the roller coaster rides of the technical charts - at least on a short-term basis. Before I go any further, let's examine some recent market history.

It was the worst May since 1940 for the stock market, dropping about 8% for all three major domestic averages. The Ithaca Experiment portfolio was up 15% for the month because it is both leveraged and short. Some people advised me to ring the cash register, take my losses, lick my wounds and buy then while stock prices were low, but I believe the market is going through more than a bad stretch. I decided to bide my time. June was another down month so my portfolio was up. Then July came and wiped out all of my gains from the previous two months from the substantial rally we experienced. We are now almost halfway through August and I'm back where I was three months ago.

There is a dichotomy in the market now. It seems you either believe that the market is going to retest the bottom of March 2008 or worse, or, you think that this is a generational buying opportunity for quality stocks. If you think you can cherry-pick high quality blue-chips now, by all means do so. Personally, I'm going to sit back in my short positions and wait. From what some market pundits are saying, my war chest will be significantly larger in a year or two from now if I am patient and bide my time. I'm from the camp that says we've already reached our highs and the next steps are much lower than this. There are too many headwinds now for the market to make another upside move, at least in my humble opinion.

I don't want to known as the boy who cried wolf or the broken clock that gets the time right twice a day, but I'm still singing my same tune of a double dip recession. In fact, I don't think we're even out of the Great Recession yet. I believe that during the last year the market has been propped up by traders with a technical bent, not anything based on solid fundamental analysis. I realize my short positions are down significantly in the year since I bought them, but with a long-term investment horizon, I still feel I will be vindicated in the long run. Wall Street tends to take August off, which is why the trading volumes are so low this month, but we are almost through the dog days and September will be here before you know it. By the New Year, I expect the market to be much, much lower. If it is not, I would have to reassess my position and consider going long.