Canterbury Market Study

Canterbury Market Study

Posted on December 26, 2018
The current S&P 500 market correction reached a 20% decline beginning from the peak on October 3, 2018 through 12/24/2018. The correction was preceded by a rare period of extremely low volatility as measured by the Canterbury Volatility Index.  Extreme low volatility is defined as a string of trading days at, or below, CVI 45.

Low volatility is a characteristic of an efficiently traded low risk market environment. Periods of extremely low volatility are typically followed by one or two outlier days of about 1.5% or greater. The S&P 500 experienced two back to back outlier days of -3.2% and -2.2% on October 10th and 11th.

Experiencing two back to back outliers, following a period with extremely low volatility, is not that uncommon. The first outlier day came as a shock to complacent investors who had not seen a meaningful down day since February. The second “outlier day,” is typically marked by having a wide trading range because there is no rational point of reference as to where the market should be trading. What was not expected was the multiple outliers that continue through today. As a point of reference, there were no outlier days for about eight months prior to October.

Canterbury Analytics conducted a study on market environments with similar characteristics to what we have been experiencing over the last three months. The study included all market periods that began with an extended period of low volatility (CVI 45 or lower) and were followed by a spike increase in volatility that led to a shift from a Bullish Market State to Transitional-Market State 6. The study used the Dow’s daily trading data going back to 1896 (about 33,000 trading days).
Observations from the Study
  • The data revealed a total of 27 periods with volatility at CVI 45 or lower that ended with one or more single day outliers of 1.5% or greater.  
  • Of these 27 periods only 5 (and now 6 including the current period) moved from Transitional- Market State 6 to one of the Bearish-Market States. 
  • The other 22 examples moved from transitional Market State 6, back to one of the Bullish-Market States and only experienced normal market corrections.
Of the 5 periods, listed above, when the market was downgraded from Market State 6, to Market State 12, what was the largest percentage decline experienced before gaining back at least 40% of the total decline?
The largest decline registered, during the 5 previous events, occurred in 1923. The Dow declined -17.5% over four and a half months. A 40% retracement of the decline followed and took about one month.
The current market behavior is very rare. There have only been 5 similar periods over the last 122 years. Of the now 6 periods, the current one has had the largest decline (-20%) and, unlike the others, has not gotten a rebound (until today) to provide an opportunity to only make minor adjustments in holdings to stabilize the fluctuations.  The big mistake made by most, is to get emotional and reduce market exposure after the first leg down and miss the eventual bounce. This is the mistake that cannot be fixed after the fact. The key is to have as much or more market exposure on the bounce as we had on the way down.
Market pricing is counter intuitive and is even more so when volatility is high. Sharp declines, that come out of nowhere, are followed by sharp advances. Advances tend to occur when most would absolutely least expect and are usually larger than most believe is possible.
Prior to today, the market was extremely oversold. The markets’ pricing has gotten way out of line with the fundamentals. Actually, those analysts who were bearish prior to October expected oil prices to go to $100 or higher.  The current unprecedented low gas prices puts immediate cash in everyone’s pockets. The early bears also predicted that interest rates on bonds would go higher. The 10 year Treasury is now down to about 2.75%.  The market went down, but the reasons that most expected to be the catalysts for the decline could not have been more wrong.
Obviously, the markets are highly emotional. The new Fed Chairman has poor communication skills when it comes to speaking the market’s language.  President Trumps negotiating tactics are magnified in a nervous environment. The trading algorithms are feeding off the volatility. The good news, as we saw today, is that the computerized trading programs kick in-on the upside as well, and when the majority least expect.
Bottom Line:
This decline still falls within the realm of noise because it is based on emotions and irrationality. It is all about portfolio management from here. The markets will take a few months to shake out. The Canterbury portfolio is set where it needs to be based on where we are now.
All corrections are scary. This one is more so than most. Emotional markets eventually workout and are soon forgotten. There is a method to handling this emotional environments. We will benefit from the fluctuations after it is over.
Enjoy your Holidays and don’t listen to the financial news for a while. It is all just opinions from talking heads. The majority will be wrong. That is a fundamental truth for the Law of supply and demand.
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.