Canterbury Volatility Index Registers the Lowest Level Since 2007

Canterbury Volatility Index Registers the Lowest Level Since 2007

Posted on September 16, 2013

Canterbury Portfolio Thermostat Weekly Update – 9/16/2013

Market State 1 – (last 4 trading days) - Long term Bullish; short term Bullish - Market State 1 is the most predictable of the Portfolio Thermostat’s 12 Market States (environments). The risk, while in MS 1, is typically around -2% to -4% from the most recent market peak.

Canterbury Volatility Index (CVI) = 51- A CVI below 75 reflects a low risk environment (Bullish). The CVI declined 2 points last week (meaning a decline in volatility). Low and flat or decreasing volatility are characteristics of a Bull market.

Market Comment:
The Portfolio Thermostat moved to Bullish - Market State 1, on the close last Tuesday, after spending 17 days in Market State 2’s short term correction phase. The maximum short term S&P 500 decline was -4.63% from the peak on 8/02 through the 8/27 trough. The fact that the CVI (volatility) remained low and actually declined 1 point, during the decline, is very rare and Bullish. It is more normal for volatility to increase during market corrections. So far this month the S&P 500 is up 3.4%, the NASDAQ is up 3.7%, and the Russell 2000 is up 4.2%.

Our short term overbought oversold indicator is currently 97% overbought. This means that a lot of buying power has been used up to get us where we are now. It would be healthy for the market to consolidate some of its short term gains and get this indicator back to a more neutral reading. That said we remain in a low risk Bull Market environment.

Our studies show that changes in market volatility can be an effective leading indicator of future market behavior and direction. For example, low or decreasing volatility is typically associated with bull markets, while high and increasing volatility is characteristic of bear markets and bubbles. The Portfolio Thermostat uses the Canterbury Volatility Index (CVI) as the market’s "volatility” thermometer. Some may find the following experiment a little more complex than what is normally covered in our normal Weekly Update. Please feel free to email me to request a specific time and date if you would like to have a phone conversation to further explain on the following commentary.

Canterbury Volatility Index (CVI) Experiment:
Last Friday, the Canterbury Volatility Index matched its lowest level seen since June 6th 2007 (CVI - 51). I spent a good part of my Saturday afternoon, during perfect golf weather, researching the significance of such an event. I reviewed almost 34 years of daily data (over 8,500 trading days). The test began by identifying every S&P 500 cycle that contained a period of declining volatility and had a CVI reading below 75. The purpose of the test was to measure the S&P 500’s expected percentage risk of decline (drawdown) during periods with lower than normal volatility.

Each observation began:

  • On the day of the S&P 500’s lowest CVI volatility reading. In other words, if Friday’s CVI - 51 would end up being the lowest volatility reading for the cycle, I would begin measuring the maximum S&P 500 decline beginning with the closing value on last Friday.

Each observation ended:

  • After a one or two day spike, in S&P 500, large enough to trigger volatility alert as defined by our Canterbury "Velocity of Volatility” indicator.·
  • The day the Portfolio Thermostat made a shift to one of the Transitional or Bear Market State environments.

The following is a summary of my findings:

  • Low and declining volatility is a primary characteristic of a Bull Market. ·
  • There were many cycles when the S&P 500 did not experience a decline from the value on the day of the lowest CVI reading. In other words, the S&P 500 continued to go higher until the end of the observation.·
  • The worst event was a -6.12% one day S&P 500 decline on 10/31/89. That day, the CVI reading spiked from the cycle low of CVI-51 to CVI-100. The S&P 500 regained the 6.12% loss over the next 55 trading days. ·
  • All other S&P 500 declines, during the 34 years tested, were less than -4%. ·
  • Each observation concluded following a new S&P 500 high or a move to one of the Bearish Market States.

Bottom Line:
When the CVI is below 75 and registers a new cycle low, like it did last Friday, the short term market risk has shown to be lower and more predictable than any other market environment observed. We remain in a low risk high reward environment for most U.S. stock market market Sectors. Any correction from here should be limited.

The Portfolio Thermostat is made up of a series of rules based software algorithms that are based on probabilities of what is most likely to occur during each of 12 market environments called Market States. The goal of the Portfolio Thermostat model is manage portfolio holdings to match and benefit throughout all market environments – Bull or Bear.

The portfolio’s assets are allocated to each of the 3 Groups and then used to purchase the strongest ETFs within each Group. Every ETF in the Portfolio Thermostat universe is assigned a "Security State” ranking that represents a Buy, Sell, or Hold rating. New purchases are determined by choosing the ETF with the highest Security State ranking. An ETF is sold when its Security State ranking changes to a Sell or when a shift in the Market State requires an adjustment in the percentage allocation of the 3 Groups. The number of holdings and the size of each holding are determined by the existing Market State and the subsequent Group percentage allocation.

Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom Hardin, Chartered Market Technician (CMT), makes all the final decisions on all investment and portfolio management decisions for Canterbury Investment Management. Tom has more than 30 years experience in the investment management industry and has broad breadth of knowledge. He is known as an innovator, educator and been revolutionary in the advancements in 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.