Extreme Low Volatility May Lead to Single-Day Outliers

Extreme Low Volatility May Lead to Single-Day Outliers

Posted on October 02, 2018
Featured Video
Our featured video this week discusses the Canterbury Volatility Index (CVI).  CVI is a leading indicator for the market and a primary component of the Canterbury Portfolio Thermostat process.

Market State 1- Bullish (24 days): The “Market State” is based on a set of proprietary indicators built into algorithms that are designed to measure efficiency of the S&P 500. The internal characteristics of S&P 500 are used to provide a leading indication of the overall health of the equity markets.
Canterbury has identified 12 different Market State environments. These Market States are separated into bullish (positive), transitional, and bearish (negative).
The first 5, of 12, Market States were shown to provide the highest average returns, while only experiencing portfolio declines equivalent to normal “market corrections” (market correction is defined as about 10% from the peak value). The 7 remaining Market States have been identified as either Transitional or outright Bearish environments. According to our studies, every market decline that exceeded a normal “market correction” occurred when the S&P 500 was in a Bearish or Transitional/bearish environment.
Canterbury Volatility Index (CVI 39): Volatility declined by another 3 points last week.  A low and decreasing CVI volatility reading (preferably CVI 75 or lower) is a Bull Market characteristic. That said, periods with extremely low volatility (volatility with CVI 45 or lower) are subject to the much discussed “one day outlier.”
These outliers can exceed 1.5% and then are typically followed by several days of normal and efficient trading. In other words, the days following a one-day outlier resemble the same, low volatility trading that occurred before the outlier.
Last Monday, I discussed the big difference between the performance of the Dow Jones Industrials and the NASDAQ 100. The Dow was up +2.25% while the NASDAQ was down -0.3% for the week ending last Friday (September 21st). Last week, The NASDAQ played some catch-up verses the Dow. The NASDAQ was down -0.3%, versus the Dow at -1.1%, and the S&P 500 was down -0.5% last week.
So why do we watch the difference in performance between the Dow, S&P 500 and NASDAQ? A primary characteristic, of a healthy bull market, is when NASDAQ 100 is outperforming the S&P 500 and Dow. The NASDAQ and S&P 500 have outperformed the Dow, and most other equity indexes for most of 2018. As a result, the S&P 500 and NASDAQ have overstated the strength of equities in general.
While so far this year the S&P 500 and NASDAQ are both up, the NASDAQ’s relative strength has been falling off for the last few weeks.  This is not necessarily a bad thing, but it does increase the likelihood of a minor pullback or correction.  Many other equity styles, like large, mid, and small cap value have not been performing as well as the S&P 500 either.  International equities, like the EAFE and Emerging Markets are actually down on the year (emerging markets is down more than -8%). 
Bottom Line:
We remain in a low risk “bullish” market environment. That said, the market is always subject to a normal pullback, or correction, of 5% to 10%. Corrections are just a part of the price we pay for owning liquid securities.
The current environment is one that has a higher than normal probability of experiencing one or two single-day outliers of 1.5% or more. The current market is also more likely, than normal, to experience a pullback that should remain within the parameters mentioned above.
Our Portfolio Thermostat operating system has already adjusted in anticipation of a pullback and will continue to adjust its ETF holdings in the event that a market decline would be enough to trigger a change to one of the Transitional or Bearish Market States. Such a shift, from a bullish to bearish environment is unlikely.
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.