The Times They Are a-Changin' Bob Dylan

The Times They Are a-Changin' Bob Dylan

Posted on November 14, 2016
Weekly Update

Market State 1: Bullish (4 days): Market State 1 represents a long and short term bullish environment.  That said the first few days, following the upgrade, can be subject to higher than normal short term risk. This is true because a great deal of buying power is used up in order to push prices high enough to positively shift the momentum upward. Currently the market is in an extreme short term overbought condition (has gone up too fast).
Canterbury Volatility Index (CVI 55) Volatility spiked up last Monday, the day before the election, which had been at CVI 48 on the Friday before. Volatility, as measured by the CVI, had been trending well below the optimal range. In fact our strategy had issued a Volatility Alert in each of the last three Weekly Updates. As stated before, “Extreme low volatility can sometimes be similar to squeezing down a spring. Volatility has now squeezed down to a level where one or two day outliers (up or down, 2% or greater) are likely to occur soon. The result can be a sharp spike in volatility as the built up pressure is released.
Now that the built up pressure has been released, expect volatility to continue to increase over the near term.
Market Comment:
The markets had a wild ride last week. The S&P 500 finally released the pressure that had built up with the +2.2%, single day outlier, last Monday the day before the election. Tuesday followed with more gains. By late Tuesday night, when it became clearer that Mr. Trump was going to win the election, Dow futures started to fall and declined as much as 827 points. The S&P 500’s futures were down more than 100 points. Japan’s Nikkei Index closed down -5.4%. By the time the

U. S. markets opened Wednesday, they had turned 180 degrees and were actually up. Last week finally ended with The Dow up 5.4%; the S&P 500 was up 3.8% and the NASDAQ finished the week up 3.8%.
Last week I discussed the many shifts and rotations among the markets leading sectors and industries. Well, it is still happening. The financial sector, basic materials and stocks related to infrastructure and defense are now leading the way. On the other hand, areas that many would consider to be conservative or defensive like Treasury bonds, utilities and consumer staples continue to take big hits. The U.S. Treasury Bond ETF (symbol TLT) was down -7.4% for the week and is down around 15% since early July.
Chart 1: U.S. Treasury Bond ETF (TLT)
As it stands now the Portfolio Thermostat is in Market State 1. The long term algorithms are positive, the volatility indicators are within the optimal ranges and last week’s advance was strong enough to turn the short term indicators positive. That said not every Market State 1 is the same.

Chart 1: Current market environment. Market State 1 (top right)

Chart 2: One year bullish market environment. Market State 1 (top right)

Source for all charts AIQ.

The current market environment is not ideal. The advance/decline line has continued to deteriorate (the number of stocks going up versus stocks going down). The large cap Dow is out performing the S&P 500 which in turn is stronger than the NASDAQ. A normal strong bull market would have the leadership opposite from what it is now (NASDAQ leading followed by the S&P 500 and then the Dow.) In addition, the market is extremely short term overbought.
Bottom Line:
Bull markets typically are subject to 8% to 10% random corrections from the highest peak. The Dow is at a new high, the S&P 500 is within 1% of its high and the NASDAQ is about 2% below the previous high. Expect some backing and filling and more shifts in leadership while the smoke clears from the election.
The Canterbury Portfolio Thermostat has made several adjustments in its holdings to reflect the changing market environment.