LunaticTrader

Investing with the Moon

Posts Tagged ‘volatility’

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.

Posted in Market Commentary | Tagged: , , , | Leave a Comment »

Updated long term scenarios and charts.

Posted by Danny on January 23, 2018

Time constraints have kept me from blogging frequently in recent months. Today I will do some catching up by reviewing the long term scenarios and indications we have been covering.

Long term readers will remember my Dow 32000 series, which I started sharing in 2013: The case for Dow 32000. Many people declared me crazy, because the Dow was still below 15k and the internet was full with bubble and crash warnings. The Dow is now above 26k and the forecast doesn’t look all that crazy anymore. Meanwhile some of my colleagues are still peddling bubble and crash warnings. I am sure they will be right some day, just like you will inevitable be right eventually if you keep calling for rain on blue sky days. But investing is about making money, not about being right eventually.

So first off, here is the updated version of my long term monthly chart from December 2016 ( see: Dow 32000 revisited):

^SP500 (Monthly) 3_1999 - 1_2018

No need to change anything here. The market has kept rising along the dashed grey line as expected and ended 2017 right into the first pink target ellipse. The move may be near its end, but the odds for an extension into the second pink target ellipse (around autumn 2018) are going up. The reason is that real volatility has stayed so low, and normally you get higher volatility in the final stages of a big move (more on that below). If the S$P 500 goes on for another 8 months and gets in the 3000+ zone then the Dow will also be near to our 32000 mark. A drop below the grey dashed line would tell us the bull market since 2009 is probably over.

Some readers have been pointing out that my 88.4y cycle is due for its peak. That’s true, but a cycle that has been observed only a few times is hardly a hypothesis, not a very reliable indication. We will need a few thousand years of stock market history before we can tell if that cycle shows up with any regularity. Also a cycle of that length should not be expected to work perfect to the month. If the bull market peaks next September it would still be a good match for this 88.4y cycle.

The solar Saros 127 will revisit us in 2019. This Saros has marked both the 1929 crash and 2001 crash (and 9/11). See: The Saros cycle and the stock market. So, it is quite possible this bull market will stretch into 2019 under increasing volatility.

There are two reasons why the odds for another year of bull market are pretty good. As I wrote in February and March 2017, a dearth of 1% down days in the S&P 500 has historically been a bullish omen for the next 12 months. Very low volatility tends to mark the middle of big moves, not the end of them. See: We got a 1% down day, what next? A 109 day period without 1% down days had just ended, but we are already in a new one, now at 107 days and counting. So here is the updated list:

down1d

Once the current series without 1% down days ends we can expect the market to climb an average 14.8% over the ensuing year (if historic tendency keeps up). That would mean S&P 500 well above 3000 in early 2019.

We are also on an extremely long streak without 2% down week, as explained in this article from last July: Why the VIX is so low and why you shouldn’t worry about it yet. We still haven’t seen a 2% down week since I wrote that article and the current streak is up to 71 weeks. We have to go back to the roaring and 50s and 60s to find longer periods of “painless investing”. Here is the updated list:

downweeks

Twenty more weeks and we would break the record from 1959. More important is what happens after the first 2% down weeks that comes. It will panic investors for sure. But again the historic average shows us that the market tends to rise another 10% in the 12 months after that first 2% down week that ends a long period of “painless investing”.

So, that’s where we stand right now. Could it be that historic tendencies will fail here and the market will suddenly crash without giving any advance warning in the form of increasing volatility? Of course, that could happen. Nothing can be ruled out. Just know that the odds are not in favor of it, if history is any indication. That’s also why VIX stays so low. Once we start getting more 1% down days and more 2% down weeks we will know that volatility is increasing and then I would expect the VIX to go up even though the S&P 500 may still be setting new all time highs. That would be a clear indication that the bull market is on its last legs. Until then I would just go along with the flow, with normal levels of caution.

Posted in Market Commentary | Tagged: , , , , | 5 Comments »

 
%d bloggers like this: