Is the Current Market Rally Sustainable?

Is the Current Market Rally Sustainable?

Posted on October 12, 2015

Weekly Update


Market State: 11A - (2 days) Transitional/Bearish. MS 11A is typically triggered by a strong kick-back rally while in a bearish Market State.

Bear markets are volatile and volatility works both ways (up and down). The current S&P 500 advance of 7% occurred over a short 7-day period. However, such a sharp advance in the current environment should not be taken as a positive sign (explanation in Market Comment below).

Canterbury Volatility Index (CVI 102). Volatility, as measured by the CVI, has declined 13 points from its peak of CVI 115 on August 26th. Even though volatility has declined slightly, we should remain wary as Canterbury studies show a strong correlation between volatility exceeding CVI 90 and a high-risk market environment.

Overbought/Oversold indicator (96% Overbought) Bearish: An Overbought reading of 95% or higher is considered to be an “extreme” reading.

It is no surprise that the most recent 7% advance is responsible for the “extreme” short-term overbought condition. The upside here is expected to be limited. A reversal in direction (in this case, down) is likely.

Market Comment:

The S&P 500 was up 3.3% last week while the Dow and NASDAQ 100 were both up 3.7% and 2.3% respectively. The NASDAQ’s relative strength is weak versus the S&P 500. This is typically NOT a bullish sign.

Source: Bloomberg

Chart 1: S&P 500

Source: AIQ

The current advance has done very little to improve the current bearish market environment.

  • The S&P 500 remains well below the 200 day moving average (DMA) and the DEATH CROSS remains intact (see Chart 1 – the 50 DMA in green is below the 200 DMA).
  • CVI volatility remains high: Bearish.
  • The market is at an extremely overbought level.
  • The advance was primarily led by the market sectors that were previously struggling the most, such as Energy, Industrials and Materials. All three sectors are in confirmed bear Market States.
  • Most of the strongest sectors had been losing momentum prior to the rally and continue to show weak relative strength.
  • There is a huge amount of overhead supply that represents sellers who would like to sell as they get back to breakeven.

Chart 2: As can be seen below, there is an overhead supply of potential sellers (circled in orange). Many of these investors will sell into rallies as they get back to breakeven. If we look at the trading range breakout (circled in black), we can also see that there is plenty of resistance at the 2040/2045 ranges. It will be difficult for the market to advance much further.

Source: AIQ

The Portfolio Thermostat model uses the Price Phase to help distinguish “whipsaws” from more serious market environments. The Price Phase is primarily used as a “confirmation indicator.”

Canterbury has tested the Price Phase indicator using trading data beginning in 1970. Evidence-based testing has provided statistically relevant results showing that it has been effective in confirming major transitions in market environments.

Chart 3: Examples of the Price Phase as a bearish confirmation indicator beginning in 1996.

Source: AIQ

Chart 4 shows the Price Phase indicator as an effective filter, used to avoid the dreaded “whipsaw.” Up until two weeks ago, the histogram of the indicator has remained above the 0 line.

Source: AIQ

Bottom Line:

The Portfolio Thermostat’s portfolio has made the appropriate adjustments in its ETF holdings to reflect the current bearish Market State. The primary goals for the current environment is as follows:

  • Adjust ETF holdings in order to keep the portfolio in one of the 5 bullish Market States.
  • Limit the portfolio’s maximum daily swings in value to the 1% to 1.2% ranges, which would be typical of a bullish market environment.
  • Limit the portfolio’s maximum, peak-to-trough, declines (drawdowns) to 8% to 10%, with rare outliers in the 12% range. A 15% or larger decline would be considered a failure in risk management.

The Portfolio Thermostat is currently positioned to potentially gain from a short-term market decline.

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.