Markets are not Efficient Portfolios

Markets are not Efficient Portfolios

Posted on April 28, 2020
The past 10 trading days (2 weeks) have featured only two days within -1.00% to +1.00%.  In that same time, the S&P 500 has seen 5 trading days beyond +/-2.00%, including 2 days beyond +/-3.00%.  What was the result of all these outlier days? Well, the last 2 weeks have been basically flat.

Two weeks ago, the S&P 500 hit its 50% retracement level, meaning it had gained back 50% of the overall peak to trough decline.  After the S&P 500 fell 1,150 points from February 19th (market peak) to March 23rd (bottom, -34%), the market rallied back 550 points (+25%) from March 24th to April 9th.  Since then, the market has been flat, fluctuating around that 50% retracement mark.  We discussed in last week’s update how this was a point of resistance, or overhead supply.

Source: AIQ

The S&P 500 is not an efficient portfolio.  It is a market index designed to measure the market capitalization of some of the largest 500 US corporations.  In all reality, the S&P 500 is mostly represented by a select few stocks.  Here are a few S&P 500 statistics:

  • Technology is currently the largest sector, representing 25% of the index-Figure 1

Source: CIM

  • The largest six S&P 500 companies make up 20% of the S&P 500 market size (Microsoft, Apple, Amazon, Facebook, Johnson & Johnson, Google)-Figure 2

Source: CIM

  • The Consumer Discretionary sector has 64 total stocks.  However, Amazon makes up 40% of the sectors market size- Figure 3

Source: CIM

  • Amazon, Apple, and Microsoft are each individually larger than the entireties of the Energy, Materials, Utilities, and Real Estate sectors- Figure 4

Source: CIM

Looking at the statistics and charts above, a few different points become clear.  One, the market is heavily driven by technology.  The technology sector makes up 25% of the S&P 500.  Not included in that 25%, is Amazon, which could arguably be a technology company. In fact, by investing in just the largest 6 stocks, out of 500, you would effectively capture 20% of the overall market. Although some sectors contain many stocks, their weights and therefore market effectiveness is largely marginalized.

Bottom Line
Stock markets are not efficient portfolios.  As time moves along, some sectors become largely overweight or underweight.  In fact, heading into the early 2000s technology bubble, technology was the largest sector, and then, prior to the financial crisis, the financial sector was the largest in the S&P 500.  The point here is, that markets measure market capitalization and do not attempt to create efficient portfolios.  You would not want one single stock, in a portfolio of 64 stocks, to represent 40% of the portfolio (Ex: Amazon in the discretionary sector).

Equity markets have gone through an emotional cycle.  After dropping -34% in 23 days, the S&P 500 went up 25% in 13 days.  In the last 10 days, it has moved in a sideways pattern, while still exhibiting volatility in the form of wide ranging up and down days.  Currently, 95% of stocks are giving AIQ (a trading software) unconfirmed sell signals, indicating that the market is largely overbought.

This is where portfolio management comes into play. The market has seen a large rally followed by a short-term sideways movement.  This has created opportunities for an Adaptive Portfolio Strategy, like the Canterbury Portfolio Thermostat to adjust by adding a few inverse positions to stabilize the portfolio.  Should the market pullback after being overbought, the Portfolio Thermostat is likely to experience much less volatility. 
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.