It's Not About Risk and Return

It's Not About Risk and Return

Posted on June 20, 2018
Market State 2: Bullish (26 days): Market State 2 Bullish/Rational - The Portfolio Thermostat operating system identifies the characteristics of 12 different market environments called “Market States.” Market States 1 and 2 have the lowest risk, of the 12 environments. Market States 1 and 2 have registered most of the new market highs.
• 5 Bullish (rational) Market States
• 4 Bearish (irrational) Market States
• 3 Transitional Market States (indicating caution, which tend to precede a change from Bullish to Bearish.)
Canterbury Volatility Index (CVI 64) – Bullish/Low Risk: The market’s volatility, as measured by the Canterbury Volatility Index has continued lower. Canterbury studies have shown statistically relevant evidence that low and decreasing volatility is a characteristic of a bullish or low-risk market environment. On the other hand, high and increasing volatility is a characteristic of a bearish or high-risk environment. The current volatility on the S&P 500 is within the optimal range between about CVI 75 and CVI 45.
The S&P 500 is a little short-term overbought. In addition, the S&P 500s price has been stuck in a tight range for the last two or three months. Tight trading ranges usually end with a short period of higher than normal volatility. The probabilities would suggest that a minor pullback, maybe -3% to -5% would actually be healthy for the market.
The S&P 500 is trading at the same level it was on February 26th (2779). As a point of reference, Small Cap Growth ETF (IJT) is up 10% during the same period while Large Cap Value Growth ETF (IVE) is down almost -3%.

Source: AIQ
Conventional wisdom would say that Small Cap Growth stocks are riskier than Large Cap Value. The truth is that every traded security, index, or asset class will have periods with low risk and positive returns and periods with higher volatility and negative returns. Therefore, one cannot say that one security is always risky or always conservative. You may find it interesting to note that the 7 to 10 year Treasury Note ETF (IEF) has had a maximum decline of about -12% between mid-July 2016 and mid-May 2018 (almost 2 years). I wouldn’t call that “conservative”, especially when almost every equity index is up during the same time-period.
Bottom Line:
The most efficient portfolio is the one that has manageable risk that can be limited to a normal “correction” of about -10% with rare outliers of just a few percentage points higher. Today’s most efficient portfolio will hold some securities that may sound more risky based on the name (i.e, Small Cap Growth). In reality, portfolio management is not about risk labels or even the flawed risk return relationship. Taking more risk does not produce higher returns over the long-run. Higher risk means higher volatility. High volatility is a bear market characteristic. High risk also means that one can expect to experience larger declines in value. How can losing more money actually help you make more money over time? The whole risk/return idea defies logic in portfolio management.

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.