S&P 500 Registers Another New High

S&P 500 Registers Another New High

Posted on April 15, 2013

Market State 1- Bullish Stock Market

Canterbury Volatility Index (CVI) = 52 - Lowest Volatility in 6 years (Bullish)

S&P 500 Stocks = 39% oversold (Bullish side of neutral)

The S&P 500 closed up 2.29% last week. A new all time high was put in on Thursday and was confirmed by a new high in our stocks only Advance Decline line. The market is getting a bit more selective, but our Portfolio Thermostat is not indicating a market top. Stocks that pay higher than average dividends are continuing to lead the way.

What is the downside risk while in Market State 1? The typical correction while in Market State 1 is between a -2% or -4% correction from the S&P 500 peak at 1593. Also, a one day isolated 200 to 275 point one day decline on the Dow can occur at any time for any reason. Such events would be considered to be a normal fluctuation but would have no meaningful impact on the Bull market or the Portfolio Thermostat’s ability to produce compounded long term returns.

In fact it would be healthy to get a small pull back over the next few days. At this point it is likely that the stock market will continue its pattern of putting in new highs. Commodities (DBC) closed at an eight month low and Gold (GDX) fell 6%. This means that rates are unlikely to rise anytime soon.

Portfolio Thermostat Background:
The weather and the market have many similarities. Both can experience volatile and unpredictable changes in climates. Like the weather, markets are neither consistent nor stable. Market environments range from efficient and stable to emotional and irrational. Market cycles with high and increasing volatility have more risk than periods with low and decreasing volatility. The probabilities of making profits in stocks are much higher when volatility is low than when it is high. As a result, portfolio holdings and allocations should be optimized based on unique characteristics of the current market environment.

Similar to the home thermostat, the Portfolio Thermostat model employs a dynamic process to stabilize portfolio volatility and adjust to the ever-changing nature of the markets. The inspiration to develop the Portfolio Thermostat process arose from the need to manage portfolio volatility and generate compounded returns throughout all market environments.

Summary of the Portfolio Thermostat Process

Step 1: Identify the Current Market Environment

The Portfolio Thermostat process begins by identifying the current Market State. Each Market State represents a different market environment and has its own unique traits and tendencies. The Portfolio Thermostat then optimizes a custom asset allocation and targets the securities that best fit the unique characteristics of the current Market State.

Step 2: Classify the Universe of Securities into Diverse Investment Classes

Most equity asset classes perform best when the S&P 500 (the market portfolio) is in a “rational” Market State. However, there are also investment classes and securities that benefit from an “irrational” or Bearish stock market. The Portfolio Thermostat model typically invests in Exchange Traded Funds (ETFs). The model first categorizes each ETF in to one of two Major Classes and then in to correlated groups and subgroups. The ETF’s Group assignment is based on several factors, such as the asset class represented, the current correlation to the U.S. stock market and the correlation to its Group and subgroups.

Step 3: Select the most efficiently diversified Securities to match the environment

Security selection may be the most important tactical component of the Portfolio Thermostat model. But the creation of an efficient portfolio requires its own process to maintain an optimal combination of diversified securities. An efficient portfolio should own securities with low correlation which can also appreciate as a group. Markets are ever changing and will affect how securities perform and how they correlate with each other. Therefore, a critical part of security selection is the process to make timely and systematic portfolio adjustments as the Market States change. The profit or loss of an individual security is much less important than its role in improving the “benefit of diversification” and maintaining a stable and efficient portfolio.

The Canterbury Portfolio Thermostat Matrix identifies 12 different Market States (environments). Of the 12 Market States, 6 are Bullish Market States, 4 Market States are Bearish, and 2 States tend to precede a transitition to a Bearish Market State, meaning caution.

Market State Description Market State Description
MS 1 Bullish Rational MS 7 Transitional Rational
MS 2 Bullish Rational MS 8 Bearish Emotional
MS 3 Bullish Emotional MS 9 Transitional Emotional
MS 4 Transitional Emotional MS 10 Bearish Emotional
MS 5 Bullish Emotional MS 11 Bearish Irrational
MS 6 Bearish Emotional MS 12 Bearish Irrational
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.