LunaticTrader

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Posts Tagged ‘ATR%’

Very low SKEW

Posted by Danny on June 17, 2019

In 2015 I posted an article, explaining why watching SKEW is more important than watching the VIX: Forget the VIX, watch the SKEW.

In brief, SKEW index has a history of staying relatively high during bull markets and suddenly become low at the start of bear markets. This is what happened both at the 2000 and 2007 stock market peaks.
The article (April 2015) pointed out that SKEW was once again dropping to lower levels, and this did indeed lead to the first serious corrections in years, with the S&P 500 finding a major low in early 2016.

I revisited this topic in March 2017, when a persistently high SKEW suggested the bull market would continue: SKEW is high again. The market kept climbing until mid 2018, with SKEW staying very high.
But since last October, SKEW has made a significant drop and has stayed low even though the market has rebounded to near its records. This is what we have now:

sp_skew

Days with SKEW below 120 have become the norm and the 50 week MA of the SKEW (blue) is dropping below the 300 week MA (green). The previous time this kind of crossover happened was in early 2008, when the global financial crisis was starting. The same thing happened in August 2000, when the dotcom mania led to a major bear market (see charts in the 2015 article).
If SKEW stays this low then I would remain very very careful. If SKEW gets back above 130 more regularly then we could well see a continuing bull market. So, I keep an eye on it.

Another measure I use to detect possible market tops is “ATR%”, which was shared in this article a few years ago: Why the VIX is so low and why you shouldn’t worry about it yet. Back then real volatility was extremely low, and as my research pointed out, markets do not peak on record low volatility. Major peaks tend to be made on higher volatility. That means we usually get plenty advance warning before the market actually turns down.

Right now we have this situation where real volatility is already well above recent record lows. Here is the updated daily ATR% for S&P 500:

spx_atr1

All time record lows for daily ATR% were reached in October 2017. The market has meanwhile set two further record highs with ATR% well above those lows. This is the kind of setup we have seen at previous major peaks. A reason for caution.

The same is seen in weekly ATR% for S&P 500:

spx_atr_w

Weekly ATR% reached a 56 year low in early 2018. Market has printed two further record highs with weekly ATR% well above those lows. So, volatility is already climbing with the S&P 500 still going up. That’s how markets tend to peak, but it doesn’t mean things will crash tomorrow. Historically the lowest weekly ATR% values tend to happen in the second half of secular bull market advances, but usually somewhat nearer to the middle of the move. E.g. in the 1990s bull market the lowest ATR% levels came in 1994 and 1995, more than five years before the end of the move. The roaring 1920s are also a good example:

atr_w_20

The lowest weekly ATR% was recorded in 1925, right in the middle of the move. Subsequent years brought rising volatility in a rising market, ending with both prices and volatility blowing off in the final ten months. That could happen again.

The recent low weekly ATR% came in early 2018. If that was again near the middle of the move then we would have another 5 to 7 years of bull market ahead of us, which would result in a major peak around 2025 accompanied by high volatility. Crazy you might think, but it would make this period similar to the 1950-60s, where the US had very high public debt (post WW2) combined with very low interest rates and ongoing productivity gains because of major innovation.
How high would the market go in that extended bull scenario? On previous occasions the S&P 500 typically doubled from the lowest weekly ATR% point to its peak several years later. If that happens again we would be looking for S&P 500 to reach 5000 or 6000 in the mid 2020s.

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