S&P 500: Does Low Fear Portend High Risk?

Below is a free excerpt of the December 9, Profit Radar Report, which takes a detailed look at various sentiment, liquidity, breadth and moment indicators to gauge the down side risk. Since this update is published out of context with all the other updates, an additional “Summary” section is provided at the end of the December 9 Profit Radar Report to provide bigger picture context.

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                                       * * * * * December 9, 2018 Profit Radar Report * * * * *

The S&P 500 closed at 2,633.08 on Friday. That’s only 1.99 points higher than the November 23 low. If the S&P would have closed at a new low, it would have been interesting to see if there are any bullish divergences.

Well, futures are down 20+ points in Sunday’s trading, so let’s just pretend the S&P closed at new lows, and look for potential divergences anyway. The blue box highlights the price action since the September high.

  • RSI-35 did not confirm the ‘new low’ (RSI-2 is near over-sold)
  • The cumulative NY Composite a/d lines did not confirm
  • The NY Composite a/d ratio did not confirm
  • The percentage of stocks below their 50-day SMA did not confirm

How about different sentiment gauges?

  • The VIX is below its October extreme
  • The VIX/VIX3M ratio is below its October extreme
  • The CBOE equity put/call ratio is at the same level
  • Contango is above its October extreme
  • The SKEW carved out a new low
  • The CBOE equity put/call ratio (5-day SMA) is below its November extreme
  • NAAIM equity exposure is about even, but above its November extreme
  • Bullish Advisors polled by II are less bearish than last week
  • Bullish Investors polled by AAII are less bearish than last week

All the above indicators show that there is little panic, certainly less panic than in October or November. This could be viewed as either 1) a bullish divergence or 2) there is enough room for the market to fall further.

Based on Elliott Wave Theory, the S&P 500 could be 1) nearing the exhaustion point of this down leg, or 2) be in a strong and sustained wave 3 lower (S&P could still rally towards or into 2,700s before next down move). The summary section below discusses which scenario is more likely.

Another attention grabber was last week’s ‘death cross,’ where the 50-day SMA fell below the 200-day SMA.

The last time death cross that received a lot of attention was in May 2016, when the 50-week SMA fell below the 100-week SMA. This was supposed to be an ‘irrefutable sell signal,’ but ultimately turned out to be one of the best buying opportunities ever.

At best, SMA crossovers have a spotty track record, and we don’t base our anlysis on such lagging indicators. For those interested, the arrows in the weekly chart below mark all bearish and bullish 200/50-day SMA crosses over the past 20 years (weekly chart shown to capture longer-term history of signals).

Shown below are various support levels that may help navigate the coming weeks, and answer the question posed above: What’ next? Sustained move lower, or quick wash out decline followed by snap-back rally?

  • 2,618: Black trend channel
  • 2,607: Wave C = 61.8% wave A
  • 2,550: Wave C = 78.6% wave A
  • 2,500: Fibonacci support going back to 2011
  • 2,478: Wave C = 100% wave A
  • 2,385: Trend line support going back to 1998
  • 2,280: Trend channel support going back to 2009

The Russell 2000 IWM is in the general green support range, with trend channel support at 143.25 and 141.30. A bounce from 143.25 – 141.30 seems likely, but sustained trade below the lower trend channel would unlock lower targets.

The Nasdaq-100 QQQ has a general range of support at 161 – 157. A break below, would likely lead to a retest of the February/March lows at 154-150.

Summary: The above analysis was based on Friday’s closing price. The S&P 500 futures chart below includes Sunday’s 20+ point drop. Trade is right around black trend channel support. Anytime prices reaches support, odds of a bounce increase.

Based on the Elliott Wave Theory structure, we are trying to figure out whether we are nearing the end of this down leg (with a potential wash out decline), or if trade will accelerate lower (as a wave 3 would).

A brief drop (1-3 days) below 2,618 (with next support at 2,607, 2,550 and perhaps as low as 2,500) followed by a quick recovery would preserve the bullish divergences and suggest sellers got ‘washed out’ and a year-end rally is underway.

Persistent trade below 2,618 and 2,607 means we need to allow for more weakness.

We will take a stab at going long (only with a small amount as this correction may carve out lower lows eventually) if the S&P 500 drops below 2,607 and subsequently rallies above 2,620 (stop-loss to be set at that day’s low). The SPY buy level is thus linked to the S&P 500 (approximate corresponding SPY levels: buy on drop below 261 followed by move above 262.10 with stop-loss at day’s low).

The very first graph of today’s update (S&P 500 in 2011 – blue box) illustrates what a wash out decline may look like.

                                        * * * * * December 9, 2018 Profit Radar Report * * * * *

SUMMARY: The lack of fear, expressed by various ‘bullish divergences,’ is likely to result in a short-term bounce. Back in September, we expected a correction toward 2,400, and that seems still likely (longer-ter S&P 500 outlook available here). A drop toward 2,400 (or at least below 2,500), would probably trigger the kind of ‘panic readings’ commensurate with a more significant bottom.

Continued updates are available via the Profit Radar Report.

Simon Maierhofer is the founder of iSPYETF and the publisher of the Profit Radar Report. Barron’s rated iSPYETF as a “trader with a good track record” (click here for Barron’s evaluation of the Profit Radar Report). The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, 24.52% in 2015, 52.26% in 2016, and 23.39% in 2017.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF e-Newsletter to get actionable ETF trade ideas delivered for free.

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Black Swan Indicator at 25-year High

The CBOE SKEW index, commonly referred to as the ‘black swan’ indicator, just spiked to the highest level in the indicators 25-year history.

Is this as scary as it sounds?

What is the SKEW?

The SKEW is calculated by the Chicago Board Options Exchange (CBOE), the same exchange that publishes the VIX.

Like the VIX, the SKEW is calculated from prices of S&P 500 out-of-the-money options. The SKEW Index basically attempts to quantify the odds of a black swan event (or S&P 500 tail risk).

CBOE identifies a black swan event as a two or more standard deviation move below the mean.

According to the CBOE, the black swan risk is negligible at a reading of 100. At 115, the risk is 6%, and at a level of 135, the risk of a black swan event is 12%. On Thursday the SKEW was at 151.22.

What is a Two Standard Deviation (Black Swan) Event?

Perhaps the easiest way to understand a two standard deviation event is with the help of Bollinger Bands.

The common default setting of the upper and lower Bollinger Band is two standard deviations above or below the 20-day SMA. The current spread between the S&P 500 20-day SMA and the Bollinger Bands is around 85 points (4%).

How Accurate is the SKEW?

The chart below captures the SKEW’s track record since the beginning of 2007.

Here are a few things worth noting:

  1. The SKEW has been moving higher since 2008, and it has taken ever-higher extremes to trigger a market reaction. It stands to reason that any stock market pullback (or black swan event) will not be commensurate to the 25-year SKEW extreme.
  2. The S&P 500 almost always reacts to SKEW extremes. Either it 1) pulls back almost instantly or 2) eventually gives back several days/weeks worth of gains.

Context is Key

The SKEW extreme appeared just as the S&P 500 is approaching an important inflection zone. The September 13 Profit Radar Report stated:

There is an open chart gap at 2,035.73. I am almost certain this gap will be filled (either during a wave 4 bounce or the subsequent rally). Depending on when we get there, 2,040 is an obvious candidate for a setup. It may be too obvious and subject to some sort of whipsaw, but 2,040 is the resistance level to watch.”

Best on the SKEW, there’s elevated risk of an upcoming pullback, especially around S&P 2,040.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

 

Stock Market Money Flow Check

Every once and a while it’s a good idea to check equity money flows, kind of like a GPS for what the money is doing.

Here’s a series of three charts to help us do just that.

1) Asset Allocation

In March, exposure to stocks (according to the American Association for Individual Investors asset allocation survey) soared to the highest level since the 2007 financial crisis.

This sounds scary, but the long-term asset allocation chart helps put things into perspective. Leading up to the 2000 market top, investors had up to 77% of their portfolio in stocks, and up to 69% in 2007.

2) Commercial Traders

The chart below shows the net S&P 500 e-mini futures contracts held by commercial traders. On balance, commercial traders are more or less neutral.

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3) VIX, Put/Call Ratio, SKEW

Chart #3 plots the S&P 500 against three different sentiment indicators:

  • CBOE SKEW: The SKEW was designed to measure the risk of a ‘Black Swan’ event. Higher SKEW = higher risk.
  • CBOE Equity Put/Call Ratio: This ratio shows to what extent option traders favor call options over put option. Lower readings = more optimism = more risk.
  • CBOE Volatility Index (VIX): The mix shows the market’s expectation of 30-day volatility. Lower VIX = Elevated risk. The VIX has lost much of its contrarian indicator mojo starting in 2012.

The CBOE SKEW (5-day SMA to smooth out daily swings) is near the lower end of a two-year range.

The CBOE equity put/call ratio dropped to 0.46 yesterday, a 1-year low. The 5-day SMA is not as low, but still at the lower end of an eight-month range.

The VIX is back to what used to be considered the ‘danger zone.’

Summary:

Money is flowing into equities, but there are no screaming investor sentiment extremes. Anyone claiming that stocks will crash because any one single sentiment gauge is at financial crisis levels is taking things out of context.

Detailed investor sentiment analysis is available to Profit Radar Report subscribers.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

 

‘Black Swan Risk Canary’ Soars to All-Time High

Many times catchy headlines do not deliver any content even remotely as interesting as the title. But this catch headline is backed up by one of the most accurate stock market indicators in recent years.

What’s the ‘Black Swan Canary?’ It’s the CBOE SKEW Index.

The SKEW Index is calculated by the CBOE. The CBOE, the same outfit responsible for the CBOE VIX.

According to CBOE, the SKEW Index is designed to measure the tail risk (= risk of outlier returns two or more standard deviations below the mean) of the S&P 500.

The SKEW Index basically estimates the probability of a large decline or ‘Black Swan’ event.

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Similar to the CBOE VIX or VIX Volatility Index (NYSEArca: VXX), the price of the S&P 500 (NYSEArca: SPY) tail risk is calculated from the price of S&P 500 out-of-the-money options.

The SKEW typically ranges from 115 to 135. Readings of 135+ suggest a 12% chance of a large decline (2 standard deviations). Readings of 115 or less suggest a 6% chance of a large decline.

The highest SKEW reading was recorded on October 16, 1998 and was matched by last Friday’s spike to 146 (the chart below was originally published in Sunday’s Profit Radar Report).

Here are probably the two most salient points about the SKEW/S&P 500 relationship:

  1. The SKEW has established a sequence of higher highs. It has taken progressively higher SKEW readings to get the S&P 500 in trouble (134 in April 2010 was enough to ‘cause’ the ‘Flash Crash’. 143 in December 2014 only led to a minor eventual pullback).
  2. Nevertheless, an elevated SKEW has tripped the S&P 500 (at least to some extent) every time. If this track record continues, Friday’s SKEW spike should cause some choppiness.

Although the 2010 and 2011 corrections were quite nasty, the label ‘Black Swan Index’ has been misleading in recent years.

This time may be different, but the SKEW has been one of the most accurate indicators in an environment that’s fooled many other trusted gauges.

The SKEW suggests a bumpy ride ahead with limited gains and elevated risk.

I always recommend looking at more than one indicator (I personally monitor various indicators from three different categories: Sentiment, seasonality and technicals).

The SKEW’s meaning is nicely enhanced by a simple Dow Jones (NYSEArca: DIA) chart. Right now a rare Dow formation offers clear levels of ruin and opportunity.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

S&P 500 ‘Sudden Drop’ Index at Historic Extreme

The Chicago Board Options Exchange (CBOE), the same outfit that formulated the VIX, also calculates the odds of a ‘two standard deviation decline,’ or large sudden drop. This ‘sudden drop’ index is at a historic extreme.

What is the ‘sudden drop’ index?

It’s the CBOE SKEW Index, calculated by the Chicago Board Options Exchange (CBOE). The CBOE also formulated the SKEW’s more popular cousin, the VIX.

According to CBOE, the SKEW is designed to measure the tail risk of the S&P 500.

What’s tail risk?

Tail risk is the risk of outlier returns two or more standard deviations below the mean. Some call this a ‘Black Swan’ event or simply a sudden drop.

Similar to the VIX, the price of the S&P 500 tail risk is calculated from the price of the S&P 500 out-of-the-money options.

The SKEW typically ranges from 115 to 135. Readings of 135 suggest a 12% chance of a large decline (2 standard deviations). Readings of 115 suggest a 6% chance of a large decline.

What is the SKEW’s track record?

SKEW Index data extends back to January 1, 1990. On June 20, 2014, the SKEW spiked to 143.26, the second highest level in its history.

Is this reason to worry?

The chart below plots the S&P 500 against the SKEW. The red bars highlight prior readings above 135.

Although the highest reading in the SKEW’s history (146.22 on 10/16/1998) did not have any ill effect on the market, the SKEW has been a trustworthy indicator since the beginning of the QE bull market.

According to the SKEW, the odds for a swift decline are near a historic max. However, the bearish SKEW should be balanced with the indicator that foresaw a persistent S&P 500 (NYSEArca: SPY) rally without correction months ago.

A detailed look at this truly fascination gauge is available here:

The Only Indicator That Foresaw a Persistent S&P 500 Rally with No Correction

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Did the Strong 2013 Market Cannibalize 2014?

2013 ended on a high note as the S&P 500 closed at the highs for the year and so did investor sentiment. So many investors are bullish; it’s worth asking how many buyers are left? Did the 2013 gains cannibalize 2014 performance?

2013 is in the bag and I’m probably not the first one to tell you that it was the best annual performance for the S&P 500 since 1997.

But that’s in the past, here’s what’s important today: Did the 2013 strong S&P 500 mortgage 2014? This probably depends on how many buyers are still out there.

A stock market without new buyers fizzles out like a fire without wood. Are there enough buyers left to drive prices higher in 2014?

The chart below plots the S&P 500 against four different sentiment measures:

  • CBOE SKEW Index (10-day SMA)
  • Percentage of bullish advisors polled by Investors Intelligence (II)
  • CBOE Equity Put/Call Ratio (inverted, 10-day SMA)
  • Percentage of bullish investors polled by AAII

To filter out some of the noise created by six years of daily data, I’m using the 10-day simple moving averages (SMA) for the CBOE SKEW Index (click here for a detailed explanation of the SKEW Index) and CBOE Equity Put/Call Ratio. The put/call ratio has been inverted to provide a better visual.

How committed are investors to the current rally?

  • The SKEW is at a 15-year high.
  • The percentage of bullish advisors is nearly as high as in October 2007.
  • The put/call ratio is the lowest since December 2010.
  • Individual investors are the most bullish in two years.

In short, buyers are already committed, which means there are not many individual buyers left (of course the Federal Reserve is still out there).

Buyers Beware

Sentiment was equally frothy only twice in the past ten years: October 2007 and December 2010 (purple boxes).

We all know what happened in 2007. In 2010 the S&P 500 (NYSEArca: SPY) and Dow Jones (NYSEArca: DIA) continued higher for several weeks before giving back a year’s worth of gains in a matter of weeks.

Summary

At this point we do not know how much upside is left (I believe it’s limited), but that there should be a correction, quite possibly a nasty correction, in the not so distant future.

Rather than hitting the sell everything button right now, it may be smarter to equip equity holdings with a trailing stop loss.

This allows you to milk the upside and limit down side risk.

The most effective stop-loss levels for stocks in general, and Dow Jones in particular, is revealed here. It’s so effective; I call it legal insider information.

Insider Trading just Became Legal – The Perfect Stop-loss Level

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (stocks, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. We are accountable for our work, because we track every recommendation (see track record below).

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Can the S&P 500 Rally another 20%?

The S&P 500 just gained 100 points in 10 days. Some suggest that further gains from an overbought condition are unlikely. This may well be correct, but with or without correction, can the S&P 500 rally another 20% from here?

The S&P 500 is trading at all-time highs and just even entertaining the idea of another rally leg makes me think of this quote:

“Anyone who believes that exponential growth can go on forever in a finite world is either a madman or an economist.”

I’m not an economist and I’d like to think that I’m no madman, but I’m starting to warm up to the idea of another sizeable rally leg.

This is partially because QE wasn’t around when Kenneth Boulding, an economist born in 1910, uttered the above words.

Although absurd when considering the economic backdrop, based on a factual and objective examination of the S&P 500 (NYSEArca: IVV) chart and investor sentiment, considerably higher stock prices are possible, even likely.

Why Now?

Stocks are nearing an overbought condition, isn’t now the wrong time to talk about another 20% rally?

The timing of this discussion is based solely on the fact that the S&P 500 (NYSEArca: SPY) has reached my long-term target around 1,750.

Technical Target Price Captured

The target was based on a 55-month long trend channel (shown in chart below) and first mentioned in the July 14 Profit Radar Report, which stated the following:

“The May 22 high did not look like a major top and the current rally doesn’t have the attributes of a major high yet either. It would be reasonable to expect some weakness with support at 1,635 followed by the next rally leg to 1,700 – 1,750.”

The October 7 Profit Radar Report confirmed the prior forecast like this: “The scenario that appears to make most sense is a quick trip into the 1,660s or 1,650s followed by another rally to new all-time highs.”

The S&P 500 chart below shows the S&P trading as high as 1,765 and Monday, tapping the upper trend channel line and capturing my long-standing target for this rally.

 

If this trend channel is going to repel the S&P 500, it needs to do so soon. Otherwise ‘persistence wears down resistance.’ Persistent trade around current levels increases the odds of higher prices.

Sentiment Analysis

Famous investor John Templeton said that: “Bull markets are born in pessimism, grow on skepticism, mature on optimism, and die on euphoria.”

Based on Templeton’s rhetoric, bull markets have four stages: Pessimism, skepticism, optimism, and euphoria.

For good reason the artificial QE bull market has been called the ‘most hated rally ever.’ Not a day goes by without banter against the Federal Reserve or Ben Bernanke.

Everyone and their grandmother knows that the Fed can’t print an economy out of trouble and that this experiment will end badly.

There’s no scientific way to prove this, but skepticism seems to be the predominant emotion of the market’s current stage.

However, to keep this analysis objective, we need to mention some rather bullish sentiment readings that popped up lately.

Bullish sentiment readings (bearish for stocks) include the equity put/call ratio, bullish asset allocation of Rydex traders, near record-high margin debt and perhaps, most importantly, a very elevated SKEW Index reading.

The SKEW Index was created by the makers of the VIX and – unlike the VIX (NYSEArca: VXX) – has been a trusted indicator this year.

To read about the implications of the current SKEW extreme go here: Watch Out! The S&P 500 Just got ‘SKEWed’

I personally believe that QE has changed the dynamic and the meaning of pretty much all sentiment gauges, but I also believe that understanding the composite sentiment picture holds the key to identifying the next investable low and the major top so many investors are waiting for.

Profit Radar Report subscribers know that I’ve been chronicling various sentiment indicators and actual money flow gauges for a long time. The correct interpretation of investor sentiment has kept us on the right side of the trade since the beginning of the year.

For a quick summary of how sentiment has affected trading thus far this year and an updated look at various current sentiment gauges and indicators click here: Assessing QE Bull Market Longevity Based on Current Investor Sentiment

Simon Maierhofer is the publisher of the Profit Radar Report.

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