Sunday, March 19, 2017

Is the High Skew a Warning Sign?

This week I am going to do something a little different since there has been little change in most of the indicators.  The $SKEW, however, has been accelerating higher the last two weeks reaching both a daily and moving average high since my database began in July 2010.  Thanks to the faithful viewers as my pageviews passed 100K last week.

This week will start with a special report on the Skew, a measure of out of the money option premiums. Typically, the Skew is considered to be a bearish indicator when it spikes because it means that option buyers are willing to pay large premiums for out of the money puts, but what I found going back to 2011 was that markets go up as often as down when the Skew spikes, but the moves are typically larger than normal. The conclusion I reached was that the direction of the price move depends on whether the premiums are set by dumb money (put buyers or speculators who by puts after a significant decline) or smart money (option writers who demand extra premium when they see high risk of large declines).

To measure this effect, I looked at the period from July 2014 to the present, overlaying the Indicator Scoreboard (wtd composite) with the Skew.  Here, I identified five periods where large price moves followed spikes in the Skew.  The Indicator Scoreboard is the top chart and the Skew is the bottom chart.  The two red bars (SELL and high Skew) were followed by declines and occurred in Sept 2014 before the Oct crash and Nov 2015 before the Jan 2016 crash.  Interestingly the last three green bars (BUY and high Skew) occurred in 2016 and were each followed by large rallies, including the Jan low, the BREXIT low, and the US election low. The recent red bar for the current period represents both the strongest SELL signal since 2011 as well as the highest Skew.

Overall this lends a lot of credibility of one possible scenario presented for the stock market in a rising interest rate environment, that is the 1987 scenario, where a six month rally saw a decline of twice as much the following six months.  This implies a possible retrace in the SPX to the low 1800s by the end of Oct.

Regular Analysis

The overall Indicator Scoreboard remains little changed.

The Short Term Indicator (VXX $ volume and Smart Beta P/C) is continuing its slow descent towards the SELL region, although it is so close that it may not matter.

Bond sentiment (TNX) has fallen back to the neutral zone.

Bearish sentiment for gold stocks (HUI) has fallen back below neutral leaving little support for further gains.

Conclusion.  The action of the $SKEW over the last two weeks has somewhat clarified the expected outcome of the Trump mania blow off, but does little to identify a top either in price or time.  Due to the influx of IRA money up to the Federal tax due date of April 15, we may see one more push higher.  Some cycles I have seen show maximum risk starting early May, six months from the US election.

Weekly Trade Alert.  Last weeks call for a top on FOMC Wed around SPX 2390 proved correct, but before the open I cancelled the SHORT on Twitter due to the Mon-Tue price action.  Lack of distribution diminishes the likelihood of even a short term pullback to SPX 2350.  On hold for now.  Updates @mrktsignals.

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