Focus on Adapting to the New Environment Not Why It Changed

Focus on Adapting to the New Environment Not Why It Changed

Posted on February 12, 2018
Market State 6: Short-Term/Transitional/Long-Term Bullish (7 trading days): 
Market State 6 is a “Transitional” environment. There are two primary outcomes when the market shifts from a “Bullish” Market State to a “Transitional” Market State.
  1. The S&P 500 moves to a “transitional phase” from a Bullish Market State. Eventually the market breaks down. It puts in a series of lower lows and lower highs and eventually turns into a bear market.
  2. The S&P 500 moves to a “transitional phase” from a Bullish Market State. It enters into a temporary state of flux and confusion. This shift in market environment is typically caused by a spike in volatility. Eventually the market settles down, establishes a new high and resumes its low risk/bullish environment.
Canterbury Analytics performed a study on every shift from a Bullish Market State to Transitional Market State 6. Our study analyzed daily market data, on the S&P 500 from 1950 through the present.
The study looked at every instance when the Market State shifted from one of the 5 “Bullish” Market States to “Transitional” Market State 6. For example: On February 2nd the market environment shifted from “Bullish” Market State 1 to “Transitional” Market State 6. The question, is what is most likely to happen next? We found that 74% of the shifts to Market State 6 went back to one of the “Bullish” Market States. The transitional market environment only shifted to a new “Bearish” Market State 26% of the time.
Based on the probabilities from our studies combined with the fact that the market is over-sold (declined too and far too fast) and that the S&P 500 stocks-only advance decline line (number of stocks going up versus down) is showing no negative divergence. * The probabilities are at least 3 to 1 that the next change in Market State will be bullish as opposed to a move to a Bearish Market State.
*S&P 500 and stocks only advance decline line. No negative divergence - Bullish
 Expected trading range 2580 to 2873

Source: AIQ
Canterbury Volatility Index (CVI 92):  Volatility has increased, and fast.  As points of reference, a reading of CVI 45 or lower falls into the extremely low volatility category. Any day that the CVI increases by 7 points or more, the Portfolio Thermostat will issue a “volatility alert” and will shift to a temporary “Transitional” Market State 6. This action occurred on February 2nd when the volatility increased by 9 points. The following days saw volatility continue to climb (next day CVI jumps 25 Points to CVI 74; and another 16 points over the next 3 days). As of today, the volatility algorithms are bearish.
The most asked question I hear on the financial news channels is… Why did the market go down so fast? The Portfolio Thermostat is not in the business of answering the question… Why? Who knows why? The Portfolio Thermostat process is in the business of answering the question…What? What is the reality of what is happening, and is our portfolio’s diversification “efficient” based on the existing Market environment? In other words, is the portfolio set up to maintain risk within a “normal correction” as defined as a -10% decline from the highest peak.
The sharp increase in volatility was expected. Periods of extremely low volatility are typically followed by a period of higher than normal volatility. The market got slapped in the face when most would least expect it. Short term technical damage has been done. It will most likely take take a few months to figure out which way is up and regain some confidence. That said, the market remains long term bullish.
Bonds are, and have been in a Bear Market for some time. Back in the day, investors would buy bonds that would mature at par value. Today, investors tend to buy Bond ETFs. The difference is that a bond fund will have a perpetual maturity. The following is an example of a 7 to 10 year Treasury Note. The fund will not mature and will always own 7-10 year notes. In other words, if rates go up for an extended period of time, the fund will decline and there is no reason to believe that it will ever get back to breakeven.

Source: AIQ
The conventional belief that bonds are always safer than stocks is simply not true. Canterbury does not assign a “risk label” to any asset class. All asset classes will experience both Bull and Bear market environments. Any security that is in one of the bullish Market States is conservative while any asset class that is in one of the bearish Market States is risky.
Bottom Line
The markets will probably remain volatile and in a trading range for a while. The Portfolio Thermostat security selection process is monitoring for ETFs with the right characteristics to improve portfolio efficiency as the new market leaders become clearer.
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.