A Balanced Portfolio Has Been Risky

A Balanced Portfolio Has Been Risky

Posted on March 08, 2022
To begin this market update, we want to remind our readers that Canterbury has identified 12 separate and unique “Market State” environments.  
  • Market States 1 through 5 are low risk (bullish)
  • Market States 6 through 8 are transitional, indicating a potential shift from a low-risk environment to a high-risk environment or vice versa.  
  • Market States 9 through 12 are high risk (bearish) market environments.
Looking at some of the major asset classes, many of them are in a volatile, bearish Market State Environment.
Asset Class Market State Volatility
S&P 500 MS 12 CVI 105 (high)
Nasdaq 100 MS 12 CVI 105 (high)
Russell 2000 MS 12 CVI 132 (high)
EAFE (international) MS 12 CVI 108 (high)
Emerging Markets MS 12 CVI 111 (high)
20-Year Treasury Bonds MS 11 CVI 108 (high)
Real Estate* MS 12 CVI 99 (high)
* Vanguard Real Estate ETF (VNQ)
The beginning of 2022 has been a difficult year for investors who employ the traditional, fixed percentage, asset allocation portfolio management method.  As you can see in the table above, many broad asset classes are in bearish Market States, and both global stocks and bonds are currently highly correlated and highly volatile.  Holding a combination of broad equities and fixed income is producing no meaningful benefit of diversification for the average balanced portfolio.

An investor with a “balanced” allocation would hope that a declining equity market would be partially offset by owning bonds.  It is assumed that diversifying between stocks and bonds would lower risk during difficult markets.  That has not been the case for over the last two years.  In fact, year-to date, both stocks and bonds have experienced a substantial increase in volatility and have had declines that have exceeded the normal 10% “correction” level.  Most stocks and bonds have also suffered several unhealthy “outlier” days (a trading day beyond +/-1.50%) which are typical of bear markets.  The 20-year treasury bond has experienced a peak-to-trough decline of more than -20% dating back to its high a year and a half ago.

Bottom line, there have not been many “safe” asset classes in this market.  Of the 11 S&P 500 Market Sectors, 7 of them are in Canterbury’s bearish Market State 12, and as our good friend David Vomund writes, “43% [of S&P 1500 stocks] are twenty percent or more off their highs.”

Where is the Market Leadership?
Where do we find the leadership in this volatile market?  In other words, what areas of the markets have benefitted from the current market environment?

We are more than two months into the year and only one S&P 500 sector is up, and that is the Energy Sector. The Energy Sector (ETF: XLE) is up more than 30% in the last 2 months.  The bad news for the market is that Energy only accounts for 3.7% of the S&P 500.  In other words, the advance in the Energy Sector has had very little impact on the broad markets and even less impact on a balanced portfolio.

As we look at Canterbury’s risk-adjusted rankings, which take into consideration a combination of relative strength and volatility, we can identify a clear theme. The markets’ leadership has been composed of a few small areas.  These areas tend to be commodity-related or inverse securities (which move in the opposite direction of their relative index).  The table below shows the top ranked market segments for both “global equities” and “alternatives to global equities”.
Rank Alternatives to Global Equities Global Equities
1 Commodity Index (has heavy oil exposure) Energy Sector
2 Natural Gas Metals and Mining
3 Palladium Oil & Gas Exploration
4 US Dollar Peru Index
5 Inverse EAFE (Europe, Asia, Far East-- inverse) Agriculture
6 Gold Food & Beverage stocks
7 Steel Aerospace & Defense
Source: Canterbury Volatility-Weighted-Relative-Strength Rankings

While many market indexes have experienced rising volatility and falling price trends, the commodity-related areas and several inverse ETFs have benefited from the market’s volatility.  Again, the problem is that most balanced, or even “aggressive” investment portfolios have very little exposure to these areas.

Portfolio Management
We are all aware that here are a lot of negative issues in the markets and in the economy right now. We are currently seeing higher costs and shortages in most goods and services. We are also experiencing many highly publicized negative events. The combination has contributed to the increasing volatility and higher-than-normal correlations among the securities in most traditional portfolios. The traditional, conservative 60/40 stock and bond portfolio is quite simply not conservative right now. In fact, the 60/40 portfolio has been, and continues to be, RISKY.

All asset classes and securities will experience both bullish and bearish phases. The efficient portfolio is a moving target because correlations and volatility change over time.  An “efficient portfolio” is made up of a combination of securities that have low correlation, which produces low portfolio volatility. As a group, the “efficient portfolio” will have a high benefit of diversification.  In today’s environment, an efficient portfolio will only feel a small impact from the high volatility in the general market. The objective of an adaptive portfolio manager is to avoid owning securities that are in volatile bearish Market States at the same time.  

That is why at Canterbury, we practice “Adaptive Portfolio Management.”  Being adaptive means that the portfolio can rotate and adapt its allocations to match up with the existing market environment.  An adaptive portfolio can rotate to the areas exhibiting more favorable market characteristics right now, rather than being constrained to a fixed balance between broad indexes and bonds.
Bottom Line
The markets are volatile and that means anything can happen.  As we have seen over the past 2 months, outlier days come in clusters.  No one knows where the markets will be at the end of this week, this month, the next 3 months, or next year.  What we do know, is what is happening right now. 

At Canterbury we aim to build the efficient portfolio for today’s market environment.  That might mean holding a combination of securities like commodities, or agriculture producers, or even inverse securities to help stabilize the portfolio’s fluctuations.  We do not want our portfolio to be a reflection of the volatility we are seeing in the broad markets.  Our goal is to create a stabile portfolio, regardless of the external market conditions.  We want our investment portfolio to feel comfortable, even when the markets are volatile.
Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom has more than 30 years of experience in the investment management industry and has a broad breadth of knowledge. He is known as an innovator, educator and has been revolutionary in the advancements of portfolio and risk management.

Canterbury Investment Management: Tom Hardin

More About Brandon Bischof

Brandon is directly responsible for managing the Canterbury Analytics Group (CAG). To date, Canterbury Analytics Group has played an important role in advancing portfolio management from a loose art form based on subjectivity and obsolete assumptions to an adaptive process with scientific rules and methods capable of providing evidence based results and statistically relevant value add results.

Every effort was used to provide accurate data and mathematical calculations to provide, what we believe to be, accurate results. Canterbury Investment Management, LLC, and its principal owners, make no guarantee of completeness or accuracy of data or calculations as well as conclusions of any statistical data or information contained in the simulation illustrated on this page. Past results or performance is in no way a guarantee of future results.