By Mark Hulbert
A DOW JONES COLUMN
The market is falling, the market is falling!
That's the urgent warning coming from devotees of an esoteric market timing gauge known as the Hindenburg Omen. They say that it is a reliable indicator of an imminent stock market crash.
But I'm not so sure.
In fact, my review of the data suggests that those using the Omen to predict a crash are good candidates to win the Chicken Little award.
The core idea behind the Hindenburg Omen, for those of you who haven't been reading your investment blogs over the last two weeks, 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.
From what I can tell, the indicator-named for the famous German aircraft that crashed and burned in 1937-was created several decades ago by a fellow named Jim Miekka, who edits a newsletter called the Sudbury Bull & Bear Report. Credit for christening this indicator the "Hindenburg Omen" goes to Kennedy Gammage, who used to edit a newsletter called the Richland Report.
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."
Certainly sounds ominous.
But upon closer scrutiny, the Omen's triggering earlier this month turns out to be not very scary at all.
For starters, there is a lot of ambiguity over how many new highs and lows must simultaneously occur in order to have bearish implications. In Fosback's textbook, he focused on occasions when the lesser of new 52-week highs and new 52-week lows amounted to at least 5% of issues traded on the NYSE. Based on his historical studies, he found that such occasions were both rare and extremely bearish.
The Hindenburg Omen, in contrast, requires a much lower threshold-2.5%, in fact. In an interview earlier this week, Fosback told me that this lower cutoff is way too low to be considered bearish.
In fact, he said, his reading of the historical data suggests to him that the current new high/new low data are solidly in the "neutral" category. (Because of other indicators entirely, furthermore, Fosback is quite bullish on the stock market right now.)
In addition, there is doubt that the recent new high/new low data even reached this already too-low threshold of 2.5%. That's because there are so many issues that now trade on the NYSE that are not operating companies.
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 August 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 be sure, followers of the Hindenburg Omen tacitly recognize that a 2.5% threshold for the lesser of new highs and new lows will produce many false signals. As a result, they have always insisted that the new high/new low data must be interpreted in the light of several other indicators, and that in conjunction with them the false signals are kept to a minimum. These other indicators are that the NYSE 10-week moving average must be rising, and that the McClellan Oscillator (a measure of market breadth) must be negative.
But Fosback has his doubts. He told me that the cobbling together of several different indicators struck him as little more than a data-mining exercise, in which a handful of otherwise disparate indicators are retrofitted after the fact to fit the data.
Also expressing doubts is Richard Russell, editor of Dow Theory Letters, who is bearish and therefore predisposed to believe the forecast of the Hindenburg Omen.
Noting the large number of advisors who have been focusing on the Hindenburg Omen, Russell wrote: "When too many chefs are involved in making the soup, the final result tends to be a mess. On this basis, I personally doubt if the Hindenburg Omen is going to work this time."
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