Market Risk is Increasing

Market Risk is Increasing

Posted on August 26, 2019

Market State 6 (Transitional): We continue to be in a transitional Market State when looking at the S&P 500.  In this case, a transitional Market State consists of rising volatility- which is the result of outlier days. In just the past 15 trading days, which dates back to August 5th, 10 of those days have been beyond +/- 1%, with 3 days nearing -3%.  As we know from studying markets, outlier days typically come in clumps, with rising volatility.  The Transitional environment we are seeing right now feels much different than the previous Bullish environment.

The S&P 500 only measures US large cap stocks. Let’s take a look at some other indices and asset class’s Market States:
Dow Jones Market State 6- Transitional
Nasdaq Market State 6- Transitional
Russell 2000 Market State 12- Bearish
EAFE Market State 6- Transitional
Emerging Markets Market State 12-Bearish
Dollar Market State 1- Bullish
Treasury Bonds Market State 1- Bullish
Gold Market State 1-Bullish
  Source: Canterbury Investment Management

Canterbury Volatility Index (CVI)- CVI 87- Volatility has been rising since July 30th.  On August 5th, there was a spike in volatility, bringing the S&P 500’s CVI reading from CVI 53 to CVI 67.  Since then, due to more outlier days, volatility has risen to its current point of CVI 87. 

Additional index volatility readings:
Dow Jones CVI 84 (increasing)
Nasdaq CVI 107 (increasing)
Russell 2000 CVI 102 (increasing)
EAFE CVI 71 (increasing)
Emerging Markets CVI 93 (increasing)
Dollar CVI 23 (Flat)
Treasury Bonds CVI 72 (increasing)
Gold CVI 75 (Flat)
  Source: Canterbury Investment Management

For most of this year, large cap US stocks have been one of the hottest equity areas.  Last week, we showed that Small Cap stocks (Russell 2000) were off nearly 13% off of their old highs.  Given the recent rise in volatility and many outlier days, the S&P 500 is still only 6% off of its old high.  Many other indices are not so lucky.
Index Percent off High
US large Caps (S&P 500) -6% (High on July 26, 2019)
US Mid Caps (S&P 400) -10% (High on Aug 29, 2018)
US Small Caps (Russell 2000) -16% (High on Aug 31, 2018)
EAFE -17.5% (High on Jan 26, 2018)
Emerging Markets -25% (High on Jan 26, 2018)
Dow Jones Industrial Average -6% (High on July 15, 2018)
Dow Jones Transportation Average -16% (High on Sept 14, 2018)
NYSE Composite -8.5% (Jan 26, 2018)
For a rising market, you would expect to see small caps lead large caps.  So far, as has been mentioned, large caps have outpaced small caps by a wide margin.  In other words, the generals are leading while the troops fall behind. You can see in the chart below, that the Russell 2000 has underperformed the S&P 500 on a relative basis for quite some time.

Source: AIQ

The chart below shows that volume is stronger to the downside.  You can see that the market’s “down” trends have had much more volume than the market’s “up” trends.  This shows that there is more conviction in the sellers; the selling is stronger than the buying.  Ideally, for a rising market, you would like to see more volume on the upside than the downside.

 Source: AIQ

Portfolio Metrics
The Canterbury Portfolio Thermostat does not aim to compete against any individual index or blended benchmark.  We know that portfolio efficiency is a moving target, and all asset classes will go in and out of favor.  The Portfolio Thermostat is an Adaptive Portfolio Strategy designed to navigate various markets and create an efficient portfolio for today’s environment- Bull or Bear.
Canterbury benchmarks its portfolio against key “internal” metrics, in order to measure portfolio efficiency.  These metrics are Portfolio State, Portfolio Volatility, and Portfolio Benefit of Diversification.  Together, these internal benchmarks create the Portfolio Efficiency Score. Below, you will find a description and reading of each metric.

Source: Canterbury Investment Management

The Portfolio Efficiency Score is currently at 100- indicating low risk during this Transitional Market environment for equities.  The Portfolio Thermostat’s internal metrics, which are Portfolio State, Volatility, and Benefit of Diversification changed since last week’s update, as the portfolio continued to adapt to the new market environment.

Portfolio State- The Portfolio remains in a bullish portfolio state.  It currently holds sectors, a style, and alternatives in a combination which creates a low-risk portfolio

Volatility- The Portfolio Thermostat’s volatility was lowered in order to stabilize the portfolio with a goal of limiting some of these large outlier days that are being seen in the markets.

Benefit of Diversification- An increased Benefit of Diversification is suitable for the volatile transitional market.  A higher B.of.D indicates a more stable moving portfolio- one with securities that are not all correlated to each other.  During periods of rising volatility, the Portfolio Thermostat adjusts its Benefit of Diversification to maintain lower volatility.   

Bottom Line
The Market remains Transitional, in a trading range, with rising volatility.  Aside from the S&P 500, some global indices/styles like the Russell 2000, EAFE, or emerging markets are behaving more bearishly. 

We have seen a few different cases over the last two years of volatility approaching extreme low levels, only to see a volatility spike that is then followed by declining volatility.  Unfortunately, this will not always be the case.  There will come a time when volatility spikes but continues rising. 

The Canterbury Portfolio Thermostat is designed to adapt to changing market environments.  The goal of an adaptive portfolio strategy is to navigate through highly emotional, highly volatile periods by limiting drawdowns and stabilizing portfolio volatility yet has the ability to participate in bull markets.  The Portfolio Thermostat is currently positioned properly for today’s environment.  It holds a combination of securities that create a portfolio with lower volatility, efficient diversification, and limited risk.
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.

Canterbury Investment Management: Tom Hardin

More About Brandon Bischof

Brandon is directly responsible for managing the Canterbury Analytics Group (CAG). To date, Canterbury Analytics Group has played an important role in advancing portfolio management from a loose art form based on subjectivity and obsolete assumptions to an adaptive process with scientific rules and methods capable of providing evidence based results and statistically relevant value add results.

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.