The State of the Portfolio Part 2 // May 16, 2016

The State of the Portfolio Part 2 // May 16, 2016

Posted on May 16, 2016
Weekly Update
Market State 8: Transitional/Bearish – The Portfolio Thermostat’s “Market State” is a reflection of the S&P 500’s current market environment (i.e. bullish, transitional or bearish), according to the following indicators

Canterbury Volatility Index:
The S&P 500’s CVI = CVI 64 (Low and Decreasing Volatility)
The Portfolio Thermostat model’s Portfolio’s CVI = CVI 23 (Low Risk)
Volatility at CVI 75 or lower is considered to be normal. 

In addition, each traded security (ETF) has its own Market State, called a Security State, that likewise reflects the security’s current bullish, transitional, or bearish characteristics and which is rated from 1 to 12.  Last and perhaps most importantly, the Canterbury Portfolio Thermostat’s model portfolio will have its own “Portfolio State.” Market States, Security States, and Portfolio States may all be related and interconnected but they are not always the same Bull, Transitional, or Bear State environment.  The break through here is that it is possible to structure a portfolio in a way to maintain a bullish Portfolio State even though the U. S. equity market is in a bearish Market State. As you can see by comparing the charts above and below, the Market State 8 – Transitional while the Canterbury model is in Portfolio State 1 – bullish.
Portfolio Thermostat Model’s Portfolio State 1: Bullish

The primary difference between Bullish verses Transitional and Bearish State environments is, in the two cases above, the markets “Transitional/Bearish Market State is subject to periods of wild swings, up and down, with almost undefinable risk. While on the other hand, the Bullish “Portfolio State” represents an “efficiently” diversified group of individual securities that, as a combined group, has adjusted to the existing market environment and has limited the portfolio’s risk. A portfolio, in one of the 5 Bullish - Portfolio States, will typically have risk exposure about equal to a normal market correction, which is defined as a -10% decline from the portfolio’s peak value.

The primary difference between a Bullish versus a Transitional or Bearish State environment is about risk and stability. 

Portfolio Thermostat’s Primary Objectives:
The following are some comments taken from our Weekly Updates posted before and after the sharp market declines on August 20th, 21st, 24th, and 25th of 2015. The Market environment had shifted from a Bullish to Bearish Market State during that time and has remained in a bearish environment since.
 8/3/15 - For now, the bulls still have the ball. Narrow trading ranges are typically resolved by a decisive break one way or the other. Things should liven up soon.

  8/24/15 - The market is in capitulation mode. A rally should occur sooner rather than later. It will take a period of time for the markets to complete a stabilization process. The Portfolio Thermostat will make the necessary adjustments as our indicators shift to reveal the new market environment.

   9/8/15 - This is the kind of market environment that the risk of getting whipsawed is much higher than transitioning straight into a bear market. The last 11 trading days (beginning on 8/20) have had 9 large outliers (days that exceed 1.5% up or down). Large point moves are normal for an early stage bear markets.

Throughout this period, the Canterbury Portfolio Thermostat made systematic adjustments in its ETF holdings in response to the changing environment. 

The following list outlines the primary objectives of the Portfolio Thermostat while the S&P 500’s Market State was Transitional or Bearish:

9/8/2015 Canterbury Weekly Update
  1. Stabilize the portfolio’s daily fluctuations to no greater than 1.5%.
The last day the Portfolio Thermostat model had an outlier over 1.5% was September 1st, 2015.
  1. Limit the portfolio’s declines to normal “bull market” corrections, typically -10% from the peak value.
The largest peak to trough decline (maximum drop) in the Portfolio Thermostat model was -2.2%, year to date.
  1. Maintain the portfolio in a Bullish Portfolio State regardless of the existing overall market environment.
The Portfolio Thermostat model has been in a bullish Portfolio State since September 15, 2015.
  1. Optimize the portfolio in response to the existing market environment.
An efficient portfolio is one that has that has the proper diversification to match the existing market environment – bull or bear. In order to maintain portfolio efficient through variable markets, the portfolio should have a systematic, objective, and testable methodology capable of adjusting its holdings to reflect the current environment.
Market Comment:
The S&P 500 is down about -2.7% from its most recent peak on April, 20th. The Portfolio Thermostat model is actually up during the same time. Neither the S&P 500 nor the Portfolio Thermostat model have broken above their highest peaks from last year. That said, the advances and declines in the S&P 500 have been larger and faster than those in the Canterbury portfolio. This has been the case because the S&P 500 has been in a Transitional or Bearish Market State environment since late August of 2015. Bear markets are volatile and unpredictable. The fluctuations tend to vary widely both up and down. In fact, the largest short term advances and declines tend to occur during bear markets.
Bottom Line:
Don’t get emotional about normal and expected bear market rallies. The last S&P 500 advance is typical of bear market behavior. The risk remains high and will most likely fall back to lower levels.
On the other hand, the portfolio is in a bullish Portfolio State environment. The charts above show the more stable characteristics of an efficient portfolio that has adjusted to the bear market. “Making money” only occurs when your portfolio registers a new high. New highs will occur more often when declines are limited to bull market normal corrections. 


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.