The market’s “crystal ball” has flashed another signal again…
This is one of the most important indicators I like to keep an eye on.
It’s called the “crystal ball” because potentially it can warn you about the future.
Let’s take a look at what it is saying to us now:
The above chart shows 3 key indices:
1. The Black Swan index or SKEW – when this is rising, it means that investors are getting nervous and expecting a sudden 2-standard deviation move (usually to the downside).
2. The Volatility Index or VIX – when this is falling, it means investors are complacent and when it is rising it means uncertainty is rising. The VIX is used as a contrarian indicator.
3. The S&P 500 or the stock market – the index of the largest 500 companies in the world. I prefer to watch the S&P instead of the Dow (because the Dow is no longer considered to be relevant).
The way the “crystal ball” works is if the VIX is extremely low (such as it is now), and if the SKEW is rising at the same time as a low VIX.
This particular combination – a rising SKEW with an extremely low VIX – is usually a good warning signal for stocks – in other words, a “bearish” signal for the stock markets.
Often this signal occurs days or weeks before the stock market actually responds. On previous occasions when this signal has occurred, the S&P has dropped down to previous levels (support).
Personally, I don’t believe that the stock markets are going to give up without a fight. So I think another push higher – potentially to 2300 – is likely before we see the S&P starting to unwind.
The tight range of the S&P is warning us of a big move coming in the stock markets. I think this move will eventually resolve to the upside, in the same direction of the larger trend and momentum.
But we should heed the warning given to us by the Black Swan index and the VIX. It does NOT mean we should short the stock market right now or to aggressively go long, but it does mean that we should be very cautious.