Time to Sound the Alarm?

The S&P500 sank almost 4 percent last week to close below 1,080.  Volume, in this down week, was higher than it was in the week before when the S&P rose.  The volume story–for most of 2010–is suggesting that there is much more conviction behind selling than buying.  The VIX (or fear( index) surged almost 21%, also adding confirmation to the price drop.

The macro economic data just seems to keep deteriorating.  Productivity fell, when it was expected to stay flat.  The international trade deficit soared; imports exceeded exports by almost $50 billion, the highest deficit since October 2008.  Initial jobless claims rose again, this time to 484,000; and the prior week’s level was revised upward.  Retail sales rose less than expected; and when sales of gas and cars are excluded, retail sales fell–when they were expected to rise.  Although consumer sentiment was slightly better than expected, the Fed came out with an ominous announcement that included the resumption, in part, of the quantitative easing that had ended in March of 2010.

Technically, the signs are very negative.  On the daily charts, the uptrend that began in early July has been decisively broken.  And there appears to be much more room to fall.  On the weekly charts, the downturn that began in late April is still intact.  Several momentum and oscillator indicators are pointing to a renewal of the strength of the downtrend. 

Spreading across many financial blogs and several major newspapers is the warning from the Hindenburg Omen, a technical indicator that called the crash of 1987 and 2008.

It’s based on several market signals, several of which involve the breadth of the market—an analysis of the number of advancing issues relative to the number of declining issues. 

Here’s a publication of the signal in Barron’s from July 2008: http://online.barrons.com/article/SB121512476279728057.html?mod=googlenews_barrons

More importantly, the Hindenburg Omen flashed its warning sign–LAST WEEK. 

Does this mean that the stock market will crash over the next 60 to 90 days?  Not necessarily. 

But given the relentlessly pessimistic macro data over the last several months, it’s becoming increasingly clear that the US economy will NOT bounce back in a typical post-WWII recovery manner.

Why does this matter?  Because today’s stock prices are predicated on the  assumption that the US economy will NOT go back into a recession. 

So this divergence is setting the stock market up for a major test.  If the US economy does NOT suddenly start to bounce back up, robustly and sustainably, then the stock market will most likely reprice all equities at a much lower price level.

Some folks would call a such a repricing a crash.

The Hindenburg Omen is signalling that this WILL happen.  And it’s been remarkably accurate in the past.

Is it time to sound the alarm?

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