When simple economics fail as an indicator for the direction of stocks, as is often the case, Wall Street likes to lean on a variety of myths, truisms, axioms, and bromides. Front and center right now: The Hindenburg Omen.
Students of history can well imagine that this omen, such as it is, does not portend good things. The name is a reference to the disastrous 1937 German Zeppelin crash in which 36 people died.
The Hindenburg Omen is supposed to foretell a stock market crash; it is triggered when, in essence, certain percentages of stocks hit 52-week highs and lows on the same day, multiple times. The more clusters of these technical readings the more likely the stock market is about to take a big hit.
The basic theory is that stocks tend to move as group, with more moving up in a bull market and more moving down in a bear market. Many stocks hitting new highs at the same time that many stocks are hitting new lows betrays an extreme degree of investor anxiety, which eventually — or so the theory goes — culminates in persistent selling.
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By one analysis, Omen readings have occurred five times in recent weeks—a heavy concentration seen only a 11 times in the last 50 years. On those occasions, only twice were stocks higher three months later—and even then just barely (by 0.5% or less, as measured by the S&P 500). Declines were as great as 10.5%.
It can be difficult to tune out this kind of noise, but you probably should. By another analysis the Hindenburg Omen is correct only 25% of the time (though it did foretell of crashes in 1987 and 2008). Another criticism is that the recent triggering was the result of trading patterns in exchange-traded bond funds, which didn’t exist when the Omen was first designed and says more about the bond market than the stock market.
It is entirely possible that the Omen only appears predictive by virtue of back testing that pulls in just the right trading data from the months preceding a downturn. Such massaged data-picking would give the Omen no more weight than, say, the Superbowl indicator, the presidential election cycle (third year is best), women’s hemlines (the shorter the better), horse-racing’s Triple Crown indicator (a sweep is bad), or the Santa Claus rally (stocks are supposed to rise the last week of December).
Then again, stocks often rise when the economy is weak, and fall when the economy is strong. Did today’s Japanese market sell-off have anything to do with the Hindenburg Omen, or was it widespread disappointment with Abenomics, as some are suggesting? So far the U.S. market doesn’t seem to have noticed either way. But investors always need something to believe in.