News Analysis date published New: 
Friday, April 19, 2013 - 14:30
New Date created: 
Friday, April 19, 2013 - 16:26
New Date last updated: 
Friday, April 19, 2013 - 14:30

The S&P's Most Bearish Indicator Is Flashing Red

Friday, April 19, 2013 2:30 PM

From moving averages and Bollinger Bands to the "golden cross," the market is littered with technical indicators.

But there is one indicator that stands alone in its accuracy and bearishness.

This indicator has been an incredible predictor of weakness in the market, flashing bright red warning signals before the market crashes of 1987 and 2008.

And right now, it is warning that trouble lies ahead for the S&P 500.

The Hindenburg Omen is widely considered to be the most bearish technical indicator in the entire market. Named for the iconic zeppelin crash, this indicator is a combination of technical factors that measure the health of the New York Stock Exchange.

The rationale is that under normal conditions, a substantial number of stocks may set either new annual highs or new annual lows, but not both at the same time. With a healthy market possessing a measure of uniformity, the simultaneous appearance of many new highs and lows is an indicator of potential weakness.

The predictive accuracy of the Hindenburg Omen has been impressive. Of the previous 25 confirmed signals, only two (8%) have not resulted in at least mild (2% to 5%) declines.

  • Major crash: 27% probability
  • Selling panic of at least 10% to 15%: 39% probability
  • Sharp decline of at least 8% to 10%: 54% probability
  • Meaningful decline of at least 5% to 8%: 77% probability
  • Mild decline of at least 2% to 5%: 92% probability
  • Signal is an outright miss: 7.7% probability (1 out of 13 times)

And now, the Hindenburg Omen has reared its bearish head once again, flashing a big warning signal to investors on April 15.

It was the first time the Hindenburg Omen has been triggered since August 2010, when the Federal Reserve narrowly averted another market crash with QE2, a second round of quantitative easing that sent stocks on a 30% rip in the next eight months.

But with the Fed recently acknowledging that it's almost tapped out on its QE program, the central bank can't be counted on to step in and save the market this time around. That means this could be the perfect time to take some profit on the big gains in the past six months and get more defensive heading into the cyclically weak months of summer.

Here are two of my favorite fixed-income investments to reduce exposure to volatility in stocks and diversify across asset classes.

PIMCO Total Return ETF (Nasdaq: BOND)
Launched in March 2012, the PIMCO Total Return exchange-traded fund has quickly become one of the most popular fixed-income investments in the market, with average daily volume of 494,000 and assets under management of $5 billion.

Consistent with legendary PIMCO fund manager Bill Gross' stellar performance history, the fund's total return has returned a peer-crushing 11% in the past year that ranks this ETF in the 90th percentile against its peers. And with a yield of 1.95%, compared with the 1.7% yield on the 10-year Treasury note, the fund has offered an impressive combination of capital gains and income.

iShares iBoxx Investment Grade Corporate Bond (NYSE: LQD)
This index of investment-grade corporate bonds is another popular destination for fixed-income investors, with average daily volume of 2.1 million and assets under management of $24 billion. This ETF offers an impressive combination of yield and value, carrying a dividend yield of 3.83% and an expense ratio of just 0.15%, a discount of more than half over its category average of 0.31%.

Risks to Consider: The Fed and other central banks worldwide are still committed to stimulating the economy. Although they have depleted much of their resources in the past four years, a sharp drop in the stock market could trigger another wave of monetary stimulation as it did in 2010.

Action to Take --> The Hindenburg Omen is one of the most bearish indicators in the market, frequently preceding a crash or significant weakness in the market. The signal just flashed red for the first time since 2010, making this a good time to take profit on big winners from the rally in the past six months and act more defensively heading into the cyclically weak summer months.

Michael Vodicka does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.