The Portfolio Thermostat's Indicators are Turning More Bullish

The Portfolio Thermostat's Indicators are Turning More Bullish

Posted on August 26, 2013

Canterbury Portfolio Thermostat Weekly Update – 8/26/2013

Market State 2 – (last 7 trading days) - long term Bullish; short term neutral - Market State 2 typically represents a normal correction in a long term Bull market.

Canterbury Volatility Index (CVI) = 54 - A CVI below 75 reflects a low risk environment (Bullish). The CVI was down 1 point for the week and is just 1 point above its lowest level for the current cycle. Low and decreasing volatility are both characteristics of a Bull market.

Our overbought/oversold indicator closed last week at 96% oversold (Bullish). An oversold reading above 95% indicates that the U.S. stock market has consolidated the previous gains enough to set up the next market advance.

Market Update:
Most market classes have experienced an interesting last couple months. This report will focus on the S&P 500 index. Between 6/24/13 and 8/02/13 (about 6 weeks) the S&P had a nice +8.7% advance. The advance was followed by a normal -3.8% correction, or consolidation, during the following 14 trading days.

The normal relationship between a market advance and volatility is to see volatility decline as the market advances. For example, the Portfolio Thermostat’s volatility indicator was at a new high (CVI 73) on the same day the S&P 500 registered its lowest level for the cycle. As the market began to advance higher, as one would expect, volatility continued to decrease. The Portfolio Thermostat’s volatility indicator eventually declined 15 points (CVI 58), from its peak and hit its low, on the day same day the S&P 500 was at its high, August 2nd at 1710.

The relationship between a market advance and its volatility is typically the opposite during a declining market verses a market advance. That said the most recent correction did not follow the normal pattern. In fact, volatility actually decreased when the S&P 500 corrected -3.8%.

The Portfolio Thermostat volatility reading was at CVI 58 on the August 2nd market peak and had declined to CVI 55 on last Wednesday’s market low. This is a very rare event but when a market declines without an increase in volatility, the Portfolio Thermostat consider such an event to be a Bullish indicator.

Our overbought/oversold indicator, on the 8/12 peak, was 99% overbought. The market was extremely extended. It only took a -3.7% correction to digest the previous +8.7% gain and move the indicator to the opposite extreme of 96% oversold. An oversold reading, above 95%, indicates that the market has experienced enough of a consolidation of the previous advance to set the stage for the next leg up.

Bottom Line:
The probabilities favor a higher U.S. and international stock market, which could mean a quick return to Bullish - Market State 1. There is a low probability of a meaningful correction from here as long as our volatility indicator remains low. In the unlikely event the Portfolio Thermostat’s CVI, volatility increases by more than 10%, from here, then the probabilities would favor a resumption of a normal Market State 2 correction in the -4% to -8% range marked from the S&P 500 peak at 1710 on August 2nd.

Emerging markets and most bonds remain in a Bear market. That said both are oversold and a short term rally is likely before returning to their respective long term Bearish ways.

Portfolio Thermostat - Market States description:

Market States are categorized by analyzing three primary inputs:·

  • 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, described in Figure 17, which include:·

  • 6 Bullish (rational) Market States ·
  • 4 Bearish (irrational) Market States·
  • 2 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 3 Groups:·

  • Group 1 – Countries, Sectors, and Industries·
  • Group 2 – Alternatives·
  • Group 3 – Styles and Indexes (Long and Inverse)

The portfolio’s assets are allocated to each of the 3 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 3 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 Portfolio Thermostat

Market States-Changing Market Environments

Canterbury Market State Long Term Risk/Volatility Market Environment
Market State 1 Bull Low Rational
Market State 2 Bull Low Rational
Market State 3 Bull Low Rational
Market State 4 Bull Low Rational
Market State 5 Bull Moderate Emotional
Market State 6 Bull High Emotional
Market State 7 Bear Moderate Emotional
Market State 8 Bear Moderate Emotional/Irrational
Market State 9 Bear Moderate Emotional
Market State 10 Bear High Irrational
Market State 11 Bear High Irrational
Market State 12 Bear High Irrational

Figure 17: The Market States matrix give an overview of the different characteristics and components that are typical of each of the 12 Market States.

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.