Is a Black Swan Event Coming? This Indicator Says It Might Be

Yesterday was a historic day, as the CBOE SKEW Index hit an all-time high. This index looks at S&P 500 tail risk and is calculated by how much investors are willing to pay to be hedged. When demand to be hedged increases, there is more perceived tail risk that something bad could be about to happen. In simpler terms, the cost of protecting against a major event (called a Black Swan) is now at a record. You can read more on CBOE.com.

This indicator shot to fame in 1990, as it soared just ahead of Iraq invading Kuwait and the subsequent S&P 500 weakness. Typically, the SKEW ranges between 100 and 150, which makes the 153 it registered yesterday all the more unique. As this gets closer to 150, that is the market’s way of saying that an event of more than two standard deviations could be on the horizon. Remember that a “standard deviation” is a mathematical term that explains how likely an event is to deviate from the average. An event of more than two standard deviations, statistically speaking, would have only a 5% chance of occurring normally.

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Now, here’s the catch. This indicator has been elevated recently and it hasn’t been correct. It spiked over 140 in late 1998 for the first time since that 1990 signal, only to see the bull market continue in full force. In fact, during the past few years, it has been consistently higher than it has ever been before. In other words, more and more investors are consistently bracing for tail risk. Think about it like this, when the SKEW is consistently higher, you have to be skeptical of how useful it is at predicting the next big drop.

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There are many worries out there, and we listed a few in the Weekly Market Commentary, “Overcoming a Wall of Worries,” but the spike in the SKEW isn’t one of them. Sure, it could be like the boy who cried wolf and be right eventually, but with its recent record so spotty we wouldn’t put too much weight in this signal as a warning sign at this time.

IMPORTANT DISCLOSURES
Past performance is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

The economic forecasts set forth in the presentation may not develop as predicted.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.

Stock investing involves risk including loss of principal.

Tail risk is a technical measure of portfolio risk that arises when there is an increased probability that an investment will experience a price swing much larger than it would be expected to under normal conditions.  Tail risks include market events that generally would have a small chance of occurring.

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The CBOE SKEW Index measures the perceived tail risk of the S&P 500 Index.

This research material has been prepared by LPL Financial LLC.

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