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AAII Investor Sentiment for the week ending March 16, 2011 showed a major reversal.  Those with a bullish view over the next six months fell to 28.5% from 36.0% last week.  Those with a bearish view over the next six months rose to 40.1% from 32.3%.  This was quite a change in sentiment.  Considering the limited down move in the SPX I would not say this is time to be a contrarian and go long as a result of the increased bearish sentiment.

The charts below have correlated very well since January 2010 and show a very wide divergence still.

AAII Investor Sentiment for the week ending March 9, 2011 showed little change over the prior report.  Those with a bullish outlook over the next six months fell to 36.0% versus 36.8% the prior week and below the historic level of 39.0%.  Those with a bearish outlook fell to 32.3% versus 33.1% in the prior week and above the historic level of 30.0%.  This report has correlated very well with the SPX and implies a move down in equities in the near term.  The question now becomes though is this yet another correlation that has broken down?

This week’s AAII sentiment survey is relatively unchanged.  Those with a bullish outlook over the next six months rose to 36.8% from 36.6% the prior week versus an historic reading of 39%. Those with a bearish outlook over the next six months dropped to 33.1% from 36.1% the prior week versus an historic reading of 30%.  The divergence between these readings and the SPX continues to stay very wide and signals pending SPX weakness.

Sentiment alone is not a timing tool for the market. But, it is useful in telling us when too many people get on the same side of the boat, which in turn tells us that conditions have ripened for a turn. I have said many times of late that the recent sentiment environment reminded me of the 2006 and 2007 period. In the chart below I have included the S&P 500 and a sentiment indicator that is comprised of the Investor Intelligence Bulls divided by Bulls plus Bears. In other words, this shows us the percentage of Bulls to total Bulls and Bears. Now, note on the chart below that during the 2007 period when this reading rose above 72%, an intermediate-term top soon followed. Now note that since the March 2009 low, every time the percent of Bulls rose above the 72% level an intermediate-term top has been at hand. Again, sentiment readings are not timing tools, but this is telling us that conditions have been ripe for another intermediate-term top and based on the price action this past week, that top may very well be in place. I will have to look at other indicators after the weekly close in order to determine if an intermediate-term sell signal has indeed been triggered and I will report this in my subscriber updates. If it proves the market has in fact made an intermediate-term top, then the correction that follows should carry this sentiment indicator down toward the 50% mark. More importantly, once price moves into our timing band for the next intermediate-term cycle low, along with these lower sentiment readings we will be able to zero in on the next intermediate-term low and buying opportunity.

In the next chart below I have included both the Dow Jones Industrials and the Transports. In light of the recent weakness, the Transports have shown more relative weakness than the Industrials. I have again received questions as to whether this relative weakness has any forecasting value from a Dow Theory perspective. The answer is no. When considering Dow theory it is the movement of both averages above or below previous secondary high points that is important. To consider only one average or to try to infer a meaning from the movement of only one average is not Dow theory.

If this correction should carry both averages below the January 28th lows, on a closing basis, then the next error I see coming from a Dow theory perspective will be that people will be mistakenly calling such price action a Dow theory “Sell Signal.” Granted, any violation of the January lows should be followed by further weakness. But, any such weakness will be associated with a decline into the next Secondary Low Point and not a Dow theory “sell signal.” So, I want to warn you ahead of time, do not listen to any such comments that you may see or hear in regard to any such weakness because it will not be correct in accordance with orthodox Dow theory.

I have begun doing free market commentary that is available at www.cyclesman.info/Articles.htm The specifics on Dow theory, my statistics, model expectations, and timing are available through a subscription to Cycles News & Views and the short-term updates. I have gone back to the inception of the Dow Jones Industrial Average in 1896 and identified the common traits associated with all major market tops. Thus, I know with a high degree of probability what this bear market rally top will look like and how to identify it. These details are covered in the monthly research letters as it unfolds. I also provide important turn point analysis using the unique Cycle Turn Indicator on the stock market, the dollar, bonds, gold, silver, oil, gasoline, the XAU and more. A subscription includes access to the monthly issues of Cycles News & Views covering the Dow theory, and very detailed statistical-based analysis plus updates 3 times a week.

WOW!  Check out the reversals in market sentiment over the past week.  The AAII report is through Tuesday so Libya would be “priced” in here.  Still, the moves are massive. Bullish sentiment dropped to 36.6% from 46.6%.  Bearish sentiment rose to 36.1% from 25.6%.   Buying the dip may be out of favor for a period of time as fear has really crept back into the market.

The SPX has correlated very well with the AAII data as shown below.  The divergence between the two is pretty large right now.  Time will tell if the red line or blue line is wrong.

This week’s AAII Investor Sentiment (asks of one’s market view over the next six months) is out and still in the bullish camp. Those answering bullish dropped 2.8% this week to a still above average 46.6%. Those answering bearish dropped 1.3% this week to a still below average of 25.6%.

The SPX continues to ignore prior correlations and the AAII sentiment data is yet another. The charts below speak for themselves as the divergence over the past few months continues to grow new levels.

The divergence continues yet again. The most recent AAII investor survey is out and has reversed its bullish although more neutral position of last week. Bulls rose to 51.5%, from 42.0% last week. Bears dropped to 26.9% from 34.3% the prior week. There are now two bulls for every one bear out there. Below are two charts showing the comparison with the SPX.

So what 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 the probability of a severe decline is quite high. This Omen has appeared before all of the stock market crashes, or panic events, of the past 25 years. All of them. No panic sell-off (greater than 15 percent) occurred over the past 25 years without the presence of a Hindenburg Omen. Another way of looking at it is, without a confirmed Hindenburg Omen, we are pretty safe. But we have an official Hindenburg Omen as of August 20th, 2010.

We got a second official confirmed Hindenburg Omen observation Wednesday, December 15th, 2010 after getting a first observation Tuesday, December 14th, 2010, meaning we are now on the clock watching for a stock market crash, and at the very least a significant decline. There is a much higher than normal probability of a stock market crash starting sometime over the next four months. All criteria were met Tuesday and Wednesday, December 14th and 15th, 2010. December 14th’s observation saw 179 NYSE New 52 Week Highs, and 113 NYSE New 52 Week Lows according to the Wall Street Journal, the lower of the two coming in at 3.58 percent, above the 2.2 percent threshold required for a Hindenburg Omen observation. Total NYSE issues traded were 3,158. New Highs were not more than twice New Lows, the McClellan Oscillator was negative at negative -16.23, and the 10 Week Moving Average is rising. The second observation on December 15thth has occurred within the required 36 day period necessary for a cluster (two or more observations) to occur. December 15th’s observation saw 156 NYSE New 52 Week Highs, and 89 NYSE New 52 Week Lows according to the Wall Street Journal, the lower of the two coming in at 2.83 percent, above the 2.2 percent threshold required for a Hindenburg Omen observation. Total NYSE issues traded were 3,143. New Highs were not more than twice New Lows, the McClellan Oscillator was negative at negative -68.80, and the 10 Week Moving Average is rising.

Now that we have a second observation, we have an official confirmed Hindenburg Omen. This is the first Hindenburg Omen since August 2010, and only the second since 2008, which of course led to the massive stock market crash in the autumn 2008, and the fourth since the Bear Market started in 2007 (we got one in 2007, one in 2008 and two here in 2010). We got crashes after both the October 2007 and June 2008 Hindenburg Omens.

The way Peter Eliades put it in his Daily Update, September 21, 2005 (www.stockcycles.com), “The rationale behind the indicator is that, 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 new highs and new lows are large, “it indicates the market is undergoing a period of extreme divergence — many stocks establishing new highs and many setting new lows as well. Such divergence is not usually conducive to future rising prices. A healthy market requires some semblance of internal uniformity, and it doesn’t matter what direction that uniformity takes. Many new highs and very few lows is obviously bullish, but so is a great many new lows accompanied by few or no new highs. This is the condition that leads to important market bottoms.”

A brief history on the origin and evolution of the Hindenburg Omen signal: It was originally adopted by Jim Miekka, editor and publisher of The Sudbury Bull and Bear Report, derived from a New High – New Low indicator developed by Gerald Appel many years ago. Because it signals the possibility of a stock market crash, my good friend, the late Kennedy Gammage, a terrific technical analyst in his own right, dubbed it the Hindenburg Omen after the famous ill-fated aircraft associated with the word “crash.”

How has this signal performed over the past 25 years, since 1985? The traditional definition of a Hindenburg Omen is that the daily number of NYSE New 52 Week Highs and the Daily number of New 52 Week Lows must both be so high as to have the lesser of the two be greater than 2.2 percent of total NYSE issues traded that day. However, this is just condition number one. The traditional definition had two more filters: That the NYSE 10 Week Moving Average is also Rising, which we consider met if it is higher than the level at any time during the previous 10 weeks (condition # 2), and that the McClellan Oscillator is negative on that same day (condition # 3). We calculate these measures each evening at www.technicalindicatorindex.com using Wall Street Journal figures for consistency. We consider the Wall Street Journal’s data as “official.” Critics have taken this Hindenburg Omen definition and pointed rightly to several failed Omens. But if we add two more filters, our proprietary research finds that the correlation to subsequent severe stock market declines is remarkable. Condition # 4 requires that New 52 Week NYSE Highs cannot be more than twice New 52 Week Lows, however it is okay for New 52 Week Lows to be more than double New 52 Week Highs. Our research found that there were two incidences where the first three conditions existed, but New Highs were more than double New Lows, and no market decline resulted. There were no instances noted where if 52 Week Highs were more than double New Lows, while the first three conditions were met, that a severe decline followed. So condition # 4 becomes a critical defining component.

The fifth condition we found important for high correlation is that for a confirmed Hindenburg Omen, in other words for it to be “official,” there must be more than one signal within a 36 day period, i.e., there must be a cluster of Hindenburg Omens (defined as two or more) to substantially increase the probability of a coming stock market plunge. Our research noted eight instances over the past 25 years — using the first four conditions — where there was just one isolated Hindenburg Omen signal over a thirty-six day period. In seven of the eight instances, no sharp declines followed. In only one instance did a sharp subsequent sell-off occur based upon a non-cluster single Omen, but in that case it was incredibly close to having a cluster of two Omens as the previous day’s McClellan Oscillator just missed being negative by a few points. We included this instance in our data that follows.

So to recap, we have an unconfirmed Hindenburg Omen if the first four conditions are met, but the fifth is not — in other words we only have one signal within a 36 day period. Once a second or more Omen occurs, we then have a confirmed Hindenburg Omen signal with substantially higher odds that a subsequent stock market plunge is coming.

Our research noted that plunges can occur as soon as the next day, or as far into the future as four months. In either case, the warning is useful. It just means, if you want to play the short side after a confirmed signal, or move out of harms way, you must be prepared to see it happen as soon as the next day, or four months from now, possibly after you forgot about it. About half occurred within 41 days.

Based upon the five parameters noted above, here’s what we found: Confirmed Hindenburg Omens are very rare. There have been only 28 confirmed Hindenburg Omen signals over the past 25 years. December 2010′s is the 29th. This is amazing when you consider that during that time span, there were roughly 6,400 trading days. Of those 6,400 trading days where it was possible to generate a confirmed official Hindenburg Omen, only 197 (3.1 percent) generated one, clustering into 28 confirmed potential stock market crash signals.

If we define a crash as a 15% decline, of the previous 28 confirmed Hindenburg Omen signals, eight (28.5 percent ) were followed by financial system threatening, life-as-we-know-it threatening stock market crashes. Three (10.7 percent) more were followed by stock market selling panics (10% to 14.9% declines). Four more (14.3 percent) resulted in sharp declines (8% to 9.9% drops). Six (21.4 percent) were followed by meaningful declines (5% to 7.9%), five (17.8 percent) saw mild declines (2.0% to 4.9%), and two (7.1 percent) were failures, with subsequent declines of 2.0% or less. Put another way, there is a 28 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 39.2 percent probability that at least a panic sell-off will occur. There is a 53.5 percent probability that a sharp decline greater than 8.0 % will occur, and there is a 74.9 percent probability that a stock market decline of at least 5 percent will occur. Only one out of roughly 14 times will this signal fail.

All the biggies over the past 25 years were preceded and identified by this signal (as defined with our five conditions). It was on the clock just before the stock market crash of the autumn of 2008. 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 (2001), and told us we would see panic selling into an October 2002 low, warned in October 2007 that a multi-month 16 percent plunge was about to start, from the DJIA’s all-time high. And it was on the clock three months before the stock market crash of the autumn 2008 into spring 2009 that wiped out 47.3 percent of the stock market’s value. Our subscribers at www.technicalindicatorindex.com were informed immediately as these signals were generated.

Here’s the data for all Hindenburg Omens over the past 25 years:

Date of first Hindenburg Omen Signal	# of Signals In Cluster	DJIA Subsequent % Decline	Time Until Decline Bottomed
12/14/2010	2	Watching	Watching
8/12/2020	6	3.7%	15 days
6/6/2008	6	47.3%	276 days
10/16/2007	9	16.3%	99 days
6/13/2007	8	7.1%	64 days
4/7/2006	9	7.0%	34 days
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
6/20/2002	5	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
2/22/1998 (3)	2	0.2%	1 day
7/21/1998	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.

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.

Another observation is that once you get two solid Hindenburg Omens in a cluster, the probability of a severe decline does not seem to increase as more Omens occur within the cluster. Sometimes a two signal cluster produced a worse decline than a 5, 11, or 17 signal cluster. But what can be said about multiple signal clusters is that the warnings are being given further out in time, keeping us on the alert. More signals also assure us a greater likelihood of better quality signals, which seems to matter. Multiple signals are telling us things are not getting better, that something continues to remain wrong with the market.

What does it mean for traders and investors when we get a confirmed Hindenburg Omen? This is really important to understand. A confirmed Hindenburg Omen is not a guarantee of a stock market crash. The odds of a crash based upon the history since 1985 is 28.5 percent. That means the odds we will not have a crash are quite high, at 71.5 percent. However, since a stock market crash is akin to economic death in many circles, you can look at the situation like this. If you were hearing from your doctor that the surgury you are contemplating stands a 30 percent chance of you dying, that becomes a very high percentage probability – one you likely do not want to take if the surgury is not absolutely necessary. A 30 percent probability of a stock market crash is extremely high when you consider that there have been only eight over the past twenty-five years, and the normal odds of a crash happening randomly are only about one-tenth of one percent. You now also have to factor that the Fed is pumping liquidity to prevent crashes once these signals occur. 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 afford to lose. Still, it is interesting that even with the heavy liquidity the Fed has been pumping around the time of the past two signals, the odds of a 5 percent decline or more remain pretty high at 74.9 percent.

We do not think it is wise to listen to folks who minimize the risk in markets pointed out by the Hindenburg Omen. We disagree with the argument that since so many of the listings on the NYSE, especially those of the New High “stock” group recorded for the Omen, are some type of Fixed Income product (ETFs, preferred stocks, etc) that the Omen isn’t really capturing “stocks” when it says “we got x % New Stock Highs,” therefore the Omen is irrelevant. Our position is that the argument that the “stock market Omen” isn’t measuring the internals of the “stock” market is false. Here is why: A huge percent of NYSE stocks are financials, banking firms, and include firms such as General Electric which is essentially a financial firm, although many people would not think of them that way. Financial firms hold substantial positions in bonds. Almost every bank listed on the NYSE carries a fixed income bond portfolio somewhere between 15 and 30 percent of their entire balance sheet, and have for years, going back far beyond the past 25 years of our research, a period of time when the Hindenburg Omen worked just fine, thank you very much. Bond and other fixed income products are prevalent throughout the distribution of companies listed NYSE, and have been for years. This Omen has worked for at least the past 25 years. It accurately called the stock market crashes of 2007 and 2008 when the NYSE included many stocks holding significant positions in fixed income instruments. It does not matter. Our entire economy has essentially moved from a manufacturing base to a financial base. This makes the Hindenburg Omen relevant. We believe it would be unwise to ignore this potential stock market crash warning.

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“You know of Jesus of Nazareth, how God anointed Him
with the Holy Spirit and with power, and how He went about
doing good, and healing all who were oppressed by the devil;
for God was with Him.
And we are witnesses of all the things He did both in the land
of the Jews and in Jerusalem.
And they also put Him to death by hanging Him on a cross.
God raised Him up on the third day, and granted that He
should become visible.
Of Him all the prophets bear witness that through His name
everyone who believes in Him receives forgiveness of sins.”

Acts 10:38-40, 43

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Due to the Thanksgiving holiday the CFTC report came out today, versus Friday. Three charts I wanted to show that support the theory that this market is finally beginning to rollover relate to copper, crude and 30 year treasuries. Historically Copper and Crude have correlated very well with SPX. Looking at the commercial accounts in the CFTC weekly report for each commodity is yet another way of gauging a change in direction.

Chart 1 – Commercial Net Positions in Copper VS SPX: The past two weeks have seen a reversal in the net position after hitting a 2010 high and indicate a SPX reversal.

Chart 2 – Commercial Net Positions Crude (NYMEX) VS SPX: Similar to copper, net positions have reversed after matching 2010 highs and look to be rolling over.

Chart 3 – 30 Year Treasury Price (inverted) VS SPX: With yields coming back, the 30 year looks to be catching a bid once again.  Based on this comparison fair value on SPX would be about 1025 today.