All Calm on the Market Front

All Calm on the Market Front

Posted on November 20, 2017
Market State 1 Bullish/Rational (57 trading days): Low Risk/Bullish market environment.
Canterbury Portfolio Analytics has identified 12 different market environments. We call these environments “Market States.” Market States 1 through 5 are low risk, “bullish” environments. The risk of decline, from the peak value is about -8% to -12% while in a “bullish” environment, and only about -5% while in Market State 1.
Market States
There are 3 Transitional Market States and 4 outright irrational, inefficient Market States. The risk, during the 7 Transitional and Bearish Market States can be high (meaning -15% to -50%). It would be an understatement to say that having a process that can tell the difference between a low risk - Bullish environment versus a high risk - Transitional or Bearish environment is critical.

Source: CIM
Canterbury Portfolio Analytics has conducted many studies on the 12 Market States and made extensive observations on the characteristics of each. The study used daily market data beginning on 12/31/1949 (over 17,000 trading days).
The following are a few S&P 500’s characteristics observed when in Market State 1:
  • A shift to Market State 1, from one of the other Market States, occurred 252 times.
  • The average number of consecutive days, in MS 1, was 28 trading days.
  • MS 1 included more trading days than any of the other 11 Market States (42.2% of the total trading days).
  • 84% of the S&P 500’s new highs occurred while in MS 1.
  • 24 new highs have been recorded during the current MS 1 57-day streak.
  • The largest peak to trough decline (maximum drawdown) experienced was -7.8%
  • 83% of the of the maximum peak to trough (max drawdowns) were less than -4%
  • The largest advance, while in MS 1, was +26.6%
  • The longest MS 1 Streak was 163 days.
  • The current 57 trading day streak is the 30th longest
Any decline experienced, while in the current Market State 1, should be limited to a normal and random 5% pullback.
Canterbury Volatility Index (CVI 30):  Volatility, as measured by the CVI, is up a couple points over the last two weeks. The increase is not meaningful and volatility remains at a historical low level.

The close Friday printed 2578 on the S&P 500, about 3 points higher than what is was on October 20 (2575). As it stands today, the market is no longer overbought. The last three weeks of sideways movement has helped the market digest its gains from the previous two months. The potential upside rewards outweigh the risk at this time. Keep in mind that one day outliers of 1.5% (up or down) are common during periods of extremely low volatility.

Source: AIQ
Canterbury Portfolio Thermostat Model:
The Canterbury Portfolio Thermostat is an adaptive strategy designed to manage all market environments – low volatility bull or high volatility bear. In order for the portfolio to meet its objectives, the following “internal” benchmarks should be met.

Canterbury Portfolio Thermostat Internal Benchmarks:

Portfolio should maintain a low risk Portfolio State:
Portfolio State: Efficient - Low risk - Bullish  

Source: CIM

Portfolio should maintain low and consistent volatility:
Portfolio Volatility (CVI 25): Low Risk - Bullish
Portfolio should limit declines to normal “corrections” of -8% to -12%:   
Portfolio maximum decline (trailing 12 months): -3.4% - Objective Met
Portfolio should have risk reduced by 30% or more through diversification:
Portfolio’s Benefit of Diversification = 35%* - Objective Met
The current diversification among the portfolio’s holdings meet all of the, internal benchmarks’ requirements to qualify as an “efficient portfolio” based on the today’s market environment: Objective Met
Canterbury’s definition of an “efficient portfolio” is one that can limit risk to normal bull market pullbacks or corrections of -8% to -12% during any market environment. On the other hand, the portfolio should perform similar to an all equity portfolio during periods of low volatility.

Source: AIQ
*Example - Benefit of Diversification (B of D):
Let’s say that the portfolio holds 10 ETFs. Each ETF has volatility of CVI 100. The average volatility would be CVI 100. Let’s say that the portfolio’s risk was reduced as a result of the diversified holdings moving different from each other. In this example, the portfolio has volatility equal to CVI 50. The net percentage Benefit of Diversification (B of D) is 50%.
  • Average of 10 Portfolio hold holdings = CVI 100
  • Volatility of portfolio = CVI 50
  • Benefit of Diversification = 50% [1-(50/100)]
Bottom Line: 
There has been a lot of news items covered by the press. The result has been not much change in the market environment over the last couple weeks. The portfolio is meeting its internal benchmarks. Not much to report.

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.