Recent Past May Look Very Different From the Future

Recent Past May Look Very Different From the Future

Posted on October 10, 2016
Weekly Update


Market State 2: Bullish (12 days): Market State 2 represents a long term bullish environment and low market volatility. Market state 2 typically occurs following a normal bull market correction. The optics of a bull market pattern will tend to look similar to a stair step pattern with a step up, to a new high (Market State 1) followed by a flat to down period (typically Market State 2), then followed by another new high (Market State 1), a higher low, higher high and so on and so forth.
Canterbury Volatility Index (CVI 57) Volatility continues to decline following the sharp 2.5% drop on September 9th. Keep in mind that low and decreasing volatility is a primary characteristic of an efficiently traded bullish market environment. That said volatility can sometimes get too low similar to squeezing down a spring. The result can be a sharp spike in volatility as the built up pressure is released. The probabilities of a one or two day outlier, meaning days up or down in the 2% range are likely if volatility continues to get squeezed down.
Market Comment:
Most major equity markets finished last week slightly down. The S&P 500 dropped 0.7% for the week while the NASDAQ declined 0.4%. The NASDAQ continues to outperform the S&P 500 which is a sign of a healthy bull market.
As I have discussed many times, markets do not go up at a steady pace and they rarely finish the year anywhere near the expected historical average return. Instead, markets tend to experience cycles of sideways trading ranges like we have seen since the end of 2013. For example, the S&P 500 traded at 1847 on 12/31/2013, it was at 1862 on 10/15/14, then 1861 on 8/25/15 and at 1829 on 2/11/16.  Investors have been on an emotional rollercoaster thinking that they are doing well during a temporary peak only to give it back a few months later.
Markets will experience many different environments over an investor’s lifetime. There will be bearish periods like 2000 to 2002 and the financial collapse in 2008. Then there are extended bull markets like the period between mid-1996 and 1998.
The primary reason that most investors do poorly over the long run is because the tendency is to make bad decisions at extreme market tops (greed), at the bottoms (fear) and in the middle when it feels like the markets will never go in the same direction for long. In other words, many investors are subject to “recent bias.” They believe the future returns will be similar to the recent past. Investors get spoiled during bull markets and expect 20% plus returns a year. On the other hand, most get discouraged by having no process to handle bear markets.  
For almost three years, the market environments have been full of rotations between the winners and losers. Sometimes Utilities, Consumer Staples and Health Care have been the best performers while Energy and Basic Materials and Industrials at the bottom. Then a few months later, the leadership flips and the opposite is true. The one thing the global markets have in common is that most suffered more than 20% declines, more than once, over the last three years.
Bottom Line:
It would be easier if the markets would just produce reasonable returns, by taking reasonable risk, every year. Unfortunately, that is not how the financial markets work. Successful investing requires more than just a simple buy, hold and rebalance. Markets are dynamic, complex and counter intuitive. Therefore the investment methodology should be robust enough to manage the dynamic nature of many different market environments.
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.