Portfolio Thermostat Market States: Revisited

Portfolio Thermostat Market States: Revisited

Posted on February 24, 2014

Canterbury Portfolio Thermostat – Weekly Update 2/24/2014

Market State 2 (28 trading days) - Long-term: Bullish; Short-term: Neutral-Bearish: Market State 2 typically follows Market State 1. Most MS 2 periods occur during a normal Bull market correction. Market State 2 will end by shifting back to Market State 1 following an advance in value.

The rotation, back and forth, between Market States 1 and 2 will occur about 80% of the time. The price will tend to trace out a stair step pattern of higher highs, followed by higher lows, followed by higher highs.

In other words, most shifts to Market State 2 will begin during a market decline and will end during an advance. Most Market State 2 price patterns will look similar to the letters V or W.

IMPORTANT POINT TO NOTE: The above sequence will hold true as long as our volatility indicators remain positive (Bullish). When our volatility indicators turn from a low volatile Bullish reading, then Market State 2 will shift to a less Bullish, Neutral or even Bearish Market State environment. Low and/or decreasing volatility is a primary characteristic of a Bull market.

Canterbury Volatility Index is at CVI 61. Last week saw a 3 point decline, from CVI 64, from the previous week. A CVI below 75 is considered to be a low risk environment.

Overbought/Oversold indicator:
Our overbought/oversold indicator closed Friday at 93% overbought (short term Bearish). A reading of 95% is considered to be an "extreme level.” According to my friend David Vomund, recently named 2013 "Market Timer of the Year” by Timer Digest, his stocks-only Advance Decline Line is moving in line with the S&P 500. If the S&P 500 reaches a new high, then it is very likely that the Advance Decline Line will also reach its high. That does not occur when a major market top is forming.

Market Comment:
Each Market State 2 environment is similar but slightly different. The current MS 2 was preceded by Market State 1, typical. The shift from MS 1 to MS 2 was a little different from the norm. For example, there was an early shift to Market State 2 after only 14 days in Market State 1. In addition, the shift to MS 2 followed only a -1.57% pull-back from the S&P 500 all time high. To put this into perspective, the typical risk in Market State 1 will experience about a -2% to -4% before moving to Market State 2.

A normal Market State 2 correction is typically in the -4% to -8% ranges. In the current case, we did see a normal MS 2 Bull market correction of -5.76% that ended on 2/03. Most of the decline occurred following two wild and wooly days; a -2.09% drop on 1/24 and -2.33% that marked the bottom on February 3rd.

It is normal to see one or two outlier trading days in the 2% range when volatility is at an extremely low level. The market’s volatility, Canterbury Volatility Index (CVI), registered its lowest level in seven years on 1/10 at CVI 46.

The S&P 500 moved back up +5.42% from the low. Interestingly it only took a -1.57% decline to shift from MS 1 to MS 2. On the other hand, a +5.42% has not been enough of an advance to shift back to Market State 1 even though the market is now "extremely” overbought.

Bottom Line: Last week, I discussed the rotation in leadership toward the more defensive market sectors and Alternative market classes that could benefit from a short term stock market pullback. It will be difficult for large-cap stocks to go much higher from here without a normal correction or a sideways consolidation period. The Portfolio Thermostat’s algorithms will continue to adjust to match the existing market environment. The Portfolio Thermostat model remains in a long term Bull Market. All current ETF holdings are classified as either an outright Buy or a Hold.

Overview of the Portfolio Thermostat Market States:

  • Long-term indicators are used to identify the primary trend of the market or security.
  • The proprietary Canterbury Volatility Index (CVI) and related volatility indicators evaluate the degree of rationality in the current market environment.
  • Short-term supply and demand indicators determine which portfolio adjustments are to be made and indicate the strength of the current Market State.

The Portfolio Thermostat process identifies 12 individual Market States, which include

  • 5 Bullish (rational) Market States
  • 4 Bearish (irrational) Market States
  • 3 Transitional Market States (which tend to precede a change from Bullish to Bearish, indicating caution)

Each of the 12 Market States is assigned a percentage allocation of the 2 Groups

  • Group 1 – Global Equities
  • Group 2 – Bonds & Alternatives

The portfolio’s assets are allocated to each of the two Groups and then used to purchase the strongest ETFs within each Group. Every ETF in the Portfolio Thermostat universe is assigned a "Security State” ranking that represents a Buy, Sell, or Hold rating. New purchases are determined by choosing the ETF with the highest Security State ranking. An ETF is sold when its Security State ranking changes to a Sell or when a shift in the Market State requires an adjustment in the percentage allocation of the two Groups. The number of holdings and the size of each holding are determined by the existing Market State and the subsequent Group percentage allocation.

Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom Hardin, Chartered Market Technician (CMT), makes all the final decisions on all investment and portfolio management decisions for Canterbury Investment Management. Tom has more than 30 years experience in the investment management industry and has broad breadth of knowledge. He is known as an innovator, educator and been revolutionary in the advancements in 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.