Ominous Signs Behind The Trump Euphoria

The market had a euphoric response to Trump’s surprise victory with many indices, sectors and stocks surging to not only their largest weekly gains in years but to new all-time highs. The big drivers are the hope for tax reform, infrastructure spending and less regulation.

The last probably being the most easily attainable and likely to provide sustainable gains for the financial and pharmaceutical sectors. Potential losers will be the high dividend paying stocks and healthcare providers and insurers with less feeding at the ACA trough.

In this morning’s 20k Monday Outlook I highlighted some of extreme moves, the divergences and dispersion to keep an eye on. I’ve listed them below with the last being the potential for a Hindenburg Omen in which I link to Dana Lyon’s work on the topic.

  • The Russell 2000 Small Cap (IWM) had its largest weekly gain over seven years, some 10.2% from the prior Friday close. Such large moves are usually associated with a ‘bear market bounce.’ Not propulsion to new highs. By contrast the Nasdaq eked out just a 1.1% gain.
  • The above speaks to the heavy rotation led to wide dispersion. While a continued rally in financials is beneficial I doubt the broader market can be carried to a new bull market simply on steel and rails. We’ll need big cap tech to supply recover. I think either names such as MSFT GOOGL and AMZN could be setting up as buying opportunities or I think the broader market will roll back over. Right now it’s the latter.
  • Bond yields saw their steepest percentage climb in over a decade. While it’s encouraging to see a normalization of rates if the economy and earnings don’t improve it will cause downward pressure on stocks, especially those dividend payers which have already absorbed selling.
  • Some internal readings such as breadth and volume were less than stellar. Some of this was due to the above mentioned rotation and the weakness in bond related securities. But one data point, new 52 week highs and new 52 week lows both hit extremes.

This type of dual reading has some pointing to the Hindenburg Omen.

Here is Dana Lyons complete article on the topic:

Those readers familiar with this topic likely gathered that our use of the word “omen” in the title of the post was not random. There is an infamous market indicator ominously called the “Hindenburg Omen”. And while there are several criteria involved in the HO, the main concept deals with large numbers of New Highs and New Lows at a given time. And although the HO is the object of plenty of Wall Street ridicule, that can probably partially be attributed to its eccentric name. Because when you dig into at least the concept behind the HO, which we have, there is a lot of evidence pointing to its validation.

Today, we look at 2 unique milestones set yesterday dealing with the ramp up in both New Highs and New Lows on the NYSE. The first is the fact that both the number of New Highs and New Lows set 3-month highs yesterday. If that sounds odd, it is. In fact, it was only the 2nd day ever in which each set a 3-month high. And since 1970, only 18 prior days saw New Highs and New Lows set as much as a 1-month high.

hindenburg-chart-1-11-14-16

So obviously, the number of NYSE New Highs and New Lows is relatively elevated. However, as the next data point shows, the level of New Highs and Lows is elevated on an absolute basis as well. To wit: Yesterday saw both the number of NYSE New Highs and New Lows account for more than 5% of all issues traded. That is another rare occurrence, with just 11 precedents since 1970.

hindeburg-image-2-11-14-16

As one can see on the chart, all of the prior instances occurred in fairly close proximity to cyclical market tops (the jury is still out on the late 2014 occurrences). Thus, unlike the prior table, in a way, S&P 500 returns following these occurrences have been unanimously poor – at least over a 2-month time frame.

hindenburg-table-return-11-14-16

As the table shows, the return in the S&P 500 has been negative 2 months after all 11 occurrences. And it wasn’t just the 2-month period that was poor. Median returns are negative across nearly all time frames from 1 week to 2 years. The 2-year result is perhaps the most eye-opening after the 2-month. The market is not typically down over a 2-year period so to see 7 of the 8 instances lower is a rare result.

What causes the elevated numbers of New Highs and New Lows? And why would it necessarily be a negative for the stock market? We’re not sure, and we don’t really care. We’re never too concerned with the “why’s” when it comes to the markets. All we care about is what is happening. And for whatever reason, the market has been especially weak – and consistently so – following the occurrence of lots of New Highs and Lows. That is a legitimate red flag currently, in our view.

— Steve Smith

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About the Author: Steve Smith