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April 23, 2006

The April 2006 Hindenburg Omen Has Now Been Confirmed
by Robert McHugh

There have only been 24 confirmed Hindenburg Omen events over the past 21 years, and it could be argued there were only 21 as there have been three declines tied to a pair of Omens a few months apart.In each instance, a sharp decline followed within 1 to 4 months; some were crashes. While April 2004's decline was mild if measuring the post 30 days, the actual decline lasted half a year, albeit choppy, and led to an 820 point, 7.8 percent decline from April to October 2004. Call it a kickoff to a mini Bear market. The point is, these are rare, and usually reliable forecasters of meaningful declines. We show them pictorially this weekend with red arrows designating when the H.O. cluster began. Yellow arrows show the subsequent damage. In all instances when the confirmed Hindenburg Omen occurred, at the very least we got a sideways interruption to the prior rally trend. In no instances did a rally ignore the Omen and keep going without at least a small sideways pause.

Further, there was not one major decline (over 10 percent) that did not first have a Hindenburg Omen present to give an early warning. We were warned every time there was a crash, or multi-month plunge, of the higher-than-normal probability of one coming, through the presence of a Hindenburg Omen.

Well, once again we have one on the clock, right now, April 2005. Since April 7th, when we observed the first one, there have been three official confirming Omens, so we now sit with four. There actually have been two more that met the old definition that many analysts followed, but just missed under our stricter requirements that we established to improve the correlation with declines (see issue 305 in our archives for that definition). Of the five criteria, these last two missed only because New Highs were more than twice New Lows. Sometimes that situation leads to false positives, so we eliminate them. But, we still have four, so this Hindenburg Omen is now confirmed.

You can go to www.technicalindicatorindex.com and click on the Guest Articles button to get a more in-depth discussion of the criteria for a Hindenburg Omen and the theory on why it works. Let's recap what this means as far as probabilities of decline:

If we define a crash as a 15% decline, of the 23 previous confirmed Hindenburg Omen signals, six (26.1 percent ) were followed by financial system threatening, life-as-we-know-it threatening stock market crashes. Three (13.0 percent) more were followed by stock market selling panics (10% to 14.9% declines). Three more (13.0 percent) resulted in sharp declines (8% to 9.9% drops). Five (21.7 percent) were followed by meaningful declines (5% to 7.9%), four (17.4 percent) saw mild declines (2.0%to 4.9%), and two (8.6 percent) were failures, with subsequent declines of 2.0% or less. Put another way, there is a greater than 25 percent probability that a stock market crash -- the big one -- will occur after we get a confirmed (more than one in a cluster) Hindenburg Omen. There is a 39 percent probability that at least a panic or crash sell-off will occur. There is a 52 percent probability that a sharp decline greater than 8.0 % will occur, and there is a 73.8 percent probability that a stock market decline of at least 5 percent will occur. Only one out of roughly 11.5 times will this signal fail. All the biggies over the past 21 years were identified by this signal (as defined with our five conditions). It was present and accounted for a few weeks before the stock market crash of 1987, was there three trading days before the mini crash panic of October 1989, showed up at the start of the 1990 recession, warned about trouble a few weeks prior to the L.T.C.M and Asian crises of 1998, announced that all was not right with the world after Y2K, telling us early 2000 was going to see a precipitous decline. The Hindenburg Omen gave us a three month heads-up on 9/11, and told us we would see panic selling into an October 2002 low.

Here's the data:

Date of first
Hindenburg
Omen Signal # of Signals
In Cluster DJIA
Subsequent
% Decline Time Until
Decline
Bottomed

4/7/2006 4 ? ?

9/21/2005 (1) 5 2.2% 22 days

4/13/2004 (2) 5 5.4% 30 days

6/20/2002 5 15.8% 30 days

23.9% 112 days

6/20/2001 2 25.5% 93 days

3/12/2001 4 11.4% 11 days

9/15/2000 9 12.4% 33 days

7/26/2000 3 9.0% 83 days

1/24/2000 6 16.4% 44 days

6/15/1999 2 6.7% 122 days

12/22/1998 (3) 2 0.2% 1 day

7/21/1998 (4) 1 19.7% 41 days

12/11/1997 11 5.8% 32 days

6/12/1996 3 8.8% 34 days

10/09/1995 6 1.7% 1 day

9/19/1994 7 8.2% 65 days

1/25/1994 14 9.6% 69 days

11/03/1993 3 2.1% 2 days

12/02/1991 9 3.5% 7 days

6/27/1990 17 16.3% 91 days

11/01/1989 36 5.0% 91 days

10/11/1989 2 10.0% 5 days

9/14/1987 5 38.2% 36 days

7/14/1986 9 3.6% 21 days

(1) In September 2005, the Fed pumped $148 billion in liquidity from the first week in September, just before the Hindenburg Omens were generated - to the third week of October, an 11 percent annual rate of growth in M-3 (2.5 times the rate of GDP growth and 5 times the reported inflation rate), to stave off a crash. The liquidity held the market to a 2.2 percent decline from the initiation of the signal.

(2) In April 2004, the Fed pumped $155 billion in liquidity from the last week in April - right after the Hindenburg Omens were generated - to the third week of May, a 22 percent annual rate of growth in M-3, to stave off a crash. Even with the liquidity, the market still fell 5.0 percent.

(3) The 12/23/1998 signal barely qualified, as the McClellan Oscillator was barely negative at -9, and New Highs were nearly double New Lows. Had this weak signal not occurred, condition # 5 would not have been met. This skin-of-the-teeth confirmation may be why it failed. It says something for having multiple, strong confirming signals.

(4) This signal came close to having two confirming signals, which may be why as a non-cluster signal, it produced a strong sell-off.

Another point to make here is that the actual stock market declines are often greater than the measures in the prior data chart. That's because oftentimes the decline from a top has already occurred before the Hindenburg Omens have been generated. These percent declines are only measuring the declines from the first Omen in a cluster. If we measured declines from the tops, it would be worse in many cases. For example, the September 2005 signals came after the September 12th high of 10,701. The autumn decline of 2005 into October 13th, 2005 bottom ended up being 545 points (5 percent) even with all the liquidity pumping by the Fed.

Here's something interesting: Oftentimes equities will rally after a Hindenburg Omen occurs, faking folks out, then the plunge comes on the other side of the hilltop. 1987 is a perfect example of that. We are also seeing that now.

As of April 21st, 2006, here are the details for the cluster of confirmed signals (4 so far) that meet all five of the conditions required for a potential stock market crash warning:

April 7th, 2006: The figures were 3,435 total issues traded on the NYSE Wednesday, with 167 New 52 Week Highs and 103 New 52 Week Lows. The common number of new highs and lows is 103, which is 3.00 percent of total issues traded, above the minimum threshold of 2.2 percent. The McClellan Oscillator came in at negative -120.43, and the 10 week NYSE was rising. New highs were not more than double new lows.

April 10th, 2006: The figures were 3,463 total issues traded on the NYSE Wednesday, with 86 New 52 Week Highs and 104 New 52 Week Lows. The common number of new highs and lows is 86, which is 2.48 percent of total issues traded, above the minimum threshold of 2.2 percent. The McClellan Oscillator came in at negative -135.71, and the 10 week NYSE was rising. New highs were not more than double new lows.

April 17th, 2006: There were 3,440 issues traded on the NYSE Monday, with 113 New 52 Week Highs and a rising 190 New 52 Week Lows. The common number of new highs and lows is 113, which is 3.28 percent of total issues traded. The McClellan Oscillator came in at negative -163.12, and the 10 week NYSE Moving Average is rising. New Highs were not more than double new lows.

April 18th, 2006 (Occurred during a mega 200 point rally, believe it or not): While The Wall Street Journal, our preferred data source, showed New Highs slightly more than twice New Lows, other services we follow count NYSE New Highs as not being more than twice New Lows. The McClellan Oscillator was negative, at minus -47.65, WSJ NYSE New Highs were 278 and New Lows were 131, the lowest common amount being 131, which is more than the 2.2 percent of total issues minimum requirement, at 3.8 percent of 3,446 issues. And, the 10 week moving average for the NYSE is rising.

Warning: Do not go short the farm! We now have to factor in that the Fed is pumping liquidity to prevent crashes once these signals occur. And now that they have hidden M-3, we cannot even monitor how much liquidity they are supplying to the Plunge Protection Team. So you do not want to go short the farm. You may want to think about taking prudent precautionary action according to your investment advisor given the much higher-than-normal odds of a crash. That may not mean shorting. It may mean increasing cash positions or hitting the sidelines for a while. Or it may mean a carefully constructed shorting strategy developed with your advisor, that limits losses, and invests only the amount which you can fully afford to lose.

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"Trust in the Lord with all your heart,
And do not lean on your own understanding,
In all your ways acknowledge Him,
And He will make your paths straight." Proverbs 3:5,6

Robert D. McHugh, Jr. Ph.D.
Main Line Investors, Inc.

Robert McHugh Ph.D. is President and CEO of Main Line Investors, Inc., a registered investment advisor in the Commonwealth of Pennsylvania, and can be reached at www.technicalindicatorindex.com. The statements, opinions and analyses presented in this newsletter are provided as a general information and education service only. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this newsletter is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. Neither Main Line Investors, Inc. nor Robert D. McHugh, Jr., Ph.D. Editor shall be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.