A Lesson on Diversification and Volatility

A Lesson on Diversification and Volatility

Posted on October 03, 2016
Weekly Update


Market State 2: Bullish: Market State 2 represents a long term bullish environment and low market volatility. The 5 bull Market States are known for low and predictable risk.

Canterbury Volatility Index (CVI 60): Volatility, as measured by the CVI remained unchanged for the week. Volatility below CVI 75 is considered to be in the “safe zone” (meaning that short term declines should not exceed a normal bull market correction of about -10% from the previous peak in value). 

Why can’t a highly diversified portfolio maintain stable risk?
We know that traded markets and securities will fluctuate in price. They always have and they always will. Most investors would agree that the primary purpose of diversification is to reduce risk by limiting portfolio volatility.
A portfolio’s volatility is a reflection of how well the current diversification among it’s holdings is working together to maintain stability. Bear in mind, though, that the changing market environments will impact how securities fluctuate in relation to each other, resulting in either a negative or positive impact on diversification. It is essential to take into account current market rationality when managing portfolios during irrational market periods. Volatility can have devastating impacts on long-term compounded returns.
Canterbury’s studies show evidence confirming that changes in the market’s, or a security’s, volatility can provide an indication of future efficiency in pricing. High and increasing volatility comes as a result of inefficient diversification and will most likely precede a downturn in price. Whereas low and stable volatility indicates efficient trading and balance between buyers and sellers. Low and decreasing volatility is a primary bullish characteristic while high and increasing volatility is a bearish trait.
Therefore, maintaining an efficient portfolio would require a process to maintain benefits of diversification through variable market environments. Such a process would be required to adjust the diversification among the portfolio’s holdings to reflect and move in concert with the ever-changing market environments.
Market Comment:
Stocks moved slightly higher last week following a mini roller coaster ride with three up days and two down days for most equity indexes. The S&P 500 finished up 0.2% while the NASDAQ was up 0.1%. The big winner was oil up +7.9%.
S&P 500 Index has broken out of a two year trading range. The first test of support in the 2130 area was successful (short term bullish).
Source: AIQ
Bottom Line:
Most equity markets are up slightly for the year but many have suffered peak to trough declines in the -15% to -25% ranges. For the most part, owning equities has required too much risk for too little reward. The S&P 500 peaked in May 2015 and traded at the same level in September 2016.
The fourth quarter is starting out better than what we have seen in recent years. We remain in a bullish Market State environment. Risk should be limited for now.
Canterbury Investment Management: Tom HardinMore 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.

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.