Author Topic: Market Timing, The Hindenburg Omen, & Bursting Bubbles  (Read 1175 times)

Offline Reginald Hudlin

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Market Timing, The Hindenburg Omen, & Bursting Bubbles
« on: August 18, 2010, 12:38:36 am »
from our friend Dale at BEVERLY HIGHLAND CAPITAL:

8/17/2010

Market Timing, The Hindenburg Omen, & Bursting Bubbles

Early this month, the S&P 500 was trading over 1,125 and we were selling stocks and raising cash.  We were lightening our long positions, not because we have a market deciphering Ouija board but simply because the market was extremely overbought and statistically unlikely to climb much higher, in the near term.

As of yesterday, the S&P 500 had pulled back about 5% from the levels reached two weeks ago. That modest, healthy pullback took the market from an overbought condition to an oversold condition – representing a change in the statistical probability that the market will resume its rally. This positive shift in directional probabilities triggered us to increase our net long position.

Simply put, when a normal functioning market is overbought, it tends to correct. When the market oversold, it tends to rally.

In the past, I’ve written about counter indicators and anecdotal counter indicators. In one email to investors, I wrote about overhearing a Starbuck’s barista touting the easy money that could be made in the market and how a barista dispensing market advice was certainly an anecdotal counter indicator. In the barista case, it marked a market top. I am always on the look out for these counter indicators, so it should not have come as a surprise when one was dropped in my lap over the weekend.

Late last week, a complicated technical market indicator called “The Hindenburg Omen”, (arguably) occurred. After carefully rereading a convoluted explanation of The Hindenburg Omen and how it almost certainly promised a total market collapse, I had an “aha moment”. A theory so obscure and intricate, that it requires several slow rereads and claims to virtually guarantee a market collapse, is probably an anecdotal counter indicator – establishing that we have put in a bottom for the current pull back.

To add a little more fuel to the fire suggesting additional markets gains from here consider what I wrote on April 8th of this year:

…over the past half century, the stock market has registered a mid-term off-presidential election year bottom, followed by a very significant stock market rally. The data shows that the percentage advance, following mid-term election year bottoms has exceeded 33% for the Dow Jones Industrial Average and 27% for the S&P 500.

Since 1962, there have been 12 mid-term, off-presidential year elections, followed by 12 market rallies of from 27% to as much as 295%!

Also consider, that based on current earnings estimates, stocks represent tremendous value. Using current earnings estimates and historical price/earnings ratios, it would be reasonable (even conservative) to expect the S&P 500 to reach 1,275 – 1,325 as we move into next year. This represents an 18 – 22% gain from yesterday’s closing level.

Finally, consider that bond yields have reached historic lows. With the Fed pledging to buy $20 billion of US Treasuries starting today, yields will be pressured even further. This excessive demand for Treasuries looks suspiciously like a bubble about to burst. If/when the Treasury bubble bursts, a likely result will be an investor flight to equities, pushing stock prices higher.

In summary, we see reasons to believe the market will rally from here. Based on this thesis, we are long the market at this time.

I always welcome your comments, criticism, and questions.