‘Black Swan’ Warning Indicator Soars to Record High

Have you even seen a black swan, I mean the actual bird? Probably not, because they are extremely rare.

That’s why the black swan has been used to describe extremely rare outlier stock market events. ‘Event’ is simply a nice way of saying crash or meltdown.

Black swan events are as rare as they are unpredictable, but the CBOE (the same outfit to create the VIX) crafted an index designed to measure the risk of a black swan event. This index is called the SKEW Index.

Here is the main difference between the VIX and SKEW: The VIX is based on implied volatility of S&P 500 at-the-money options while the SKEW is based on implied volatility of far out-of-the-money S&P 500 options.

Here is how the SKEW works: Readings of 100 mean that the risk of a black swan event is low. For every 5-point increase in the SKEW Index, the risk of a black swan event increases 1.4%.

On Friday, the SKEW Index closed at 155.31, which is the second highest reading since 1990 (as far back as SKEW data goes). A reading of 155 also means that the risk of a black swan event is 15.4% higher than usual.

With the theoretical stuff out of the way, let’s see if the SKEW Index actually works.

Does the SKEW work?

The chart below plots the S&P 500 agains the SKEW Index (going back to 1990). The SKEW moved above 150 only on 17 of 12,967 trading days (that’s 0.13% of the time). And none of those 17 days happened before 2015.

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The next chart makes it easier to identify those 17 times. Here are the key takeaways:

13 of the 16 prior signals (81%) saw any gains erased within the next 3 month

3 of the 16 prior signals (19%) saw significant further gains (2 of those gains were erased within 18 months)

Summary

The SKEW Index deserves credit for flashing warning signals prior to the 2016, 2018 and 2020 declines. It needs to be noted though that those signals were about 2 months too early. It will take a break below support to edge the potential black swan risk closer to reality.

Continuous 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. 

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S&P 500 – Strong but Ugly

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Let’s face it, S&P 500 performance has been strong but ugly … and downright boring to watch. Despite the yawn environment, I just discovered a historic pattern that played out 90% of the time (see below).

Yes, while markets are grinding I’m running dozens of screens to gain an edge for the next move.

For example, the last S&P 500 all-time high (last Thursday) also saw:

– Cumulative NY Composite a/d lines at all-time highs

– 88% of S&P 500 stocks above their 50-day SMA

– 95% of S&P 500 stocks above their 200-day SMA

– Only 58% of volume flowing in advancing stocks (10-day SMA)

Running a screen based on the above parameters yields no hits, which means it never happened before.

We can’t learn much from a sample size of 1, but lowering the threshold gives as more precedents to work with.

The yellow lines highlight when less restrictive criteria (see chart) were met. Unfortunately the sample size couldn’t be more conflicting (don’t shoot the messenger). We have some signals right before the 2007 and 2020 crash and others during the 2013 and 2020 melt-up.

Let’s take a different approach. Instead of scanning for similar past occurrences based on breadth we’ll look at performance.

Here is our baseline:

  1. From January – April 2021, the S&P 500 was up 11.32%
  2. In 2020 (prior year), the S&P 500 recorded a 16.26% gain
  3. 2021 was a post election year

Going back to 1970, we now identify the following:

– Years S&P 500 was up more than 10% on April 30

It happened 14 other years

– Years S&P 500 gained 16% +/-5% the year before

It happened 5 other years

– Years that were a post election year (like 2021)

It happened 1 other year

– Years with a similar chart trajectory (correlation)

Based on the above criteria, the gray graphs reflect the January – April performance of the 10 years most similar to 2021 (in red).

The logical next step is to chart the forward performance of the 10 most similar years, which is exactly what I did. After doing that, I look for common themes.

This study revealed an interesting commonality: 3 month later (which corresponds to August 1), the S&P 500 had the same directional bias 90% of the time. The full study was published in yesterday’s Profit Radar Report.

Even dull markets can offer clues about future performance … if you look hard enough … or have someone who does the searching for you.

Continued updates, out-of-the box analysis and forward performance based on historic precedents are available via the Profit Radar Report.

Barron’s rates iSPYETF a “trader with a good track record,” and Investor’s Business Daily writes “Simon says and the market is playing along.”SPX