Transitional Markets are like a Box of Chocolates

Transitional Markets are like a Box of Chocolates

Posted on April 10, 2018
Market State 6: Transitional/Long-Term Bullish (9 days)
The S&P 500 remains in Market State 6 following last week’s movements.  According to the Canterbury Portfolio Thermostat Indicators, Market State 6 characteristics are as follows:
Long-Term: Bullish
Volatility: High
Short-Term Supply/Demand: Negative
The Canterbury Portfolio Analytics Team keeps record of historical S&P500 Market States dating back to 1950.  As a reminder, here are some statistics on market state 6:
  • The market has experienced a Market State 6 transitional environment 75 times.
  • Market State 6 returns to Bull Market State 75% of the time
  • Market State 6 returns to Market State 1 40% of the time
  • Market State 6 breaks Long-Term support and turns Bearish 25% of the time
Canterbury Volatility Index (CVI 102):
Volatility remains high following a wide-range of daily fluctuations.  Like prior weeks, last week featured a few “outlier” days.  According to studies performed by Canterbury Portfolio Analytics, the daily standard deviation of a rational market environment is around 0.75%.  Based on a normal, random distribution, daily fluctuations should occur as follows:
-0.75% to +0.75%....................................Multiple Times Weekly
<-0.75% or >0.75%..................................About once per week
<-1.50% or >+1.50%..............................About once per month
<-2.25% or >+2.25%..............................Every 1.5 Years
I want to reiterate and expand on a chart from last week’s blog:

Source: CIM
The chart above, labeled “S&P 500 Daily Returns”, highlights the different ranges listed and the Canterbury Volatility Index.  Daily Returns within the green/yellow zones should occur on a weekly basis; returns within the red zone should occur monthly; and returns beyond the red zone should only occur once every 1.5 years… according to a normal, random distribution. 
All of calendar year 2017 was highlighted by extreme low volatility (CVI<45).  Notice how daily returns within the year 2017 follow a more than orderly, almost expected pattern of rational fluctuation, with very few (also less than expected) movements falling within the “once per month” zone.  As volatility increases in January 2018, we start to see increased fluctuation in daily movement, including 8 days that should only occur monthly and 4 days exceeding fluctuations that should only occur every 1.5 years.
From this chart of daily fluctuation and CVI, we can conclude that high volatility environments do not follow a normal, random distribution.  Daily fluctuations will follow a wider, more unpredictable range if volatility is higher.  Going forward, we can expect to see large movements, either up or down, as we navigate through this transitional market environment.
We have mentioned it many times before, but I want to discuss a little bit about the advance/decline line (A/D line).  The A/D line measures market breadth.  It is a measure of how many stocks are advancing versus declining.  The A/D line is a leading indicator and good measure of the likelihood of a bear market.  If markets are putting in new highs, but the A/D line is trending lower, it is a signal that heavier weighted stocks are pulling the market upwards, but many smaller stocks are starting to fall lower (this would be a bearish indication).  Conversely, if the market is trending lower and the A/D line is trending higher, it is an indication of a possible bull market in sight.
So, what about today’s environment?

Source: AIQ
From the above chart, we notice that the S&P 500 puts in a high in January (1), followed by a lower relative high in early March (2).  The A/D line, however, puts in a new high at the same time of the lower price relative high (4).  This is what is called a Positive Divergence.  Price is putting in lower high, yet the indicator puts in a new high.  This means that while, as a group, the index is falling, more stocks are rising than declining. 
Additionally, as the market puts in two lows around the same 2580 level in both early February (5) and mid-March (6), the A/D line puts in a higher low (8), which is another positive signal as the amount of stocks falling in March is less than the amount of stocks that had fallen in early February when the first low was established.
While this is not an “end all, be all” indicator, higher highs and higher lows in the Advance/Decline line is a good sign.
Bottom Line:
Often, investors try to find reasons for why things happen and try to make a prediction on where things are going.  Markets, however, are less about the predictability of return, but all about the predictability of risk.  We cannot make a prediction on what the market’s daily fluctuation will be, but we can create an efficient portfolio for today’s environment. 
It is especially important to have an adaptive system, like the Canterbury Portfolio Thermostat, that can adjust to all market environments.  Transitional environments, like the one we see today, are like a box of chocolates: you never know what you are going to get. 
The Canterbury Portfolio Thermostat will continue to make the adjustments necessary to keep your portfolio stable throughout this market environment, as well as any market environment ahead- whether it is bull or bear.
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.