A Twelve Month Snapshot // May 23, 2016

A Twelve Month Snapshot // May 23, 2016

Posted on May 23, 2016
Weekly Update

Market State 8: Transitional/Bearish – The Portfolio Thermostat’s “Market State” is a reflection of the S&P 500’s current market environment (i.e. bullish, transitional or bearish), according to the following indicators.

Portfolio Thermostat Model: Portfolio State 1

The Canterbury Portfolio Thermostat model portfolio remains in bullish Portfolio State 1. Our studies show statistically relevant evidence that a portfolio that qualifies as being in one of the five “Bullish Portfolio States” will typically have risk similar to a normal bull market correction, defined as a -10% decline from the highest peak value.
A “Bullish” Portfolio State represents an “efficiently” diversified portfolio of individual securities that, as a combined group, can limit the short-term risk in the current market environment.  Transitional and Bear Market States, on the other hand, will be subject to periods of wild swings, up and down, with almost undefinable risk.
Investor profits only occur when their portfolio registers a new high in value, which would imply that portfolio declines should be limited as much as possible. Smaller declines (from the peak value) should require less time to recover and establish a new high, while large declines that come as a result of bear markets can require many years to get back to break-even and even longer to produce the investor’s average return goal.
The current Market State 8 environment is risky (Transitional/Bearish), but the Portfolio Thermostat model will continue to adjust its ETF holdings in order to maintain a Bullish Portfolio State 1.
Market Comment:
Back in late January, the market was undergoing an extended bearish period, registering a market low on January 20th, 2016. On that day, a number of indices saw a sizeable percentage of its stocks down 30% or more. 29.2% of the S&P 500 Index was down 30% or more, while over half of the stocks in the Nasdaq Composite Index and Russell 2000 Index (56.1% and 55.8% respectively) experienced the same.
As we have mentioned in past weekly updates, uncontrolled risk of this short-term nature does have a significant impact on long-term results. From the market high on May 20th, 2015 to the January low of this year, this translates into a peak-to-trough decline of -15.1% for the S&P 500, -17.6% for the Nasdaq Composite, and -26.0% for the Russell 2000. Each of these peak-to-trough declines exceeds the normal range of 8% - 12% of a bull market correction, reflecting greater risk than is efficient.
Since the January low, the market has begun a period of shaky recovery. From January 20, 2016 up through last Thursday (May 19th), the S&P 500 and the Russell 2000 have both gone up nearly 10% (9.7% and 9.6% respectively), while the Nasdaq has experienced a more modest 5.4% gain.
Further recovery is still needed though. From the high in May of last year until now, the S&P 500 is still down -4.4%. That is one whole year in which no money was made, but rather lost.
Bottom Line:
The above snapshot of the past 12 months is just one of many illustrations of why risk management (short-term and long-term) is so essential for any investment process.
All portfolios and markets will experience random short-term fluctuations. In the case of an “efficiently diversified” tactical portfolio, random fluctuations should fall within the band of approximately 8% to 12% from the peak. As the portfolio pushes to new highs, the band shifts with it so that the new maximum downward fluctuation should nevertheless leave the portfolio at a higher value than the last band, continually pushing your portfolio to grow.
With a buy and hold strategy, however, a portfolio will inevitably go through both bull and bear markets, which means that the portfolio could see a typical correction during a bull market in the 8-12% range (the same as the Thermostat model) but could be exposed to corrections as great as 30% or higher during risky environments. The consequences of straying outside the bands could be significant. 


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.

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.