Understanding Systematic Market Risk

Understanding Systematic Market Risk

Posted on November 23, 2015

Weekly Update


Market State 8A – (7 days) Transitional/Bear Market State: The Portfolio Thermostat has been in a “Transitional/Bearish” Market State for the last 64 trading days. Beginning on August 20th, the Portfolio Thermostat shifted out of a “Bullish” Market State 2.

The Market State “A” Series (7A, 8A, 9A, 10A, 11A, and 12A) denote Transitional/Bearish Market environments, which follow a Bullish Market State. Confirmed Bearish Market States follow the Transitional A Series.

Canterbury Volatility Index (CVI 82) – Neutral: Volatility ticked-down just a little (2 points) from the previous week. A volatility reading between CVI 75 and CVI 90 is considered to be a Neutral reading when combined with the current declining trend, which has continued falling since the September 8th peak of CVI 115.

Overbought/Oversold indicator (57% Oversold) Short term - Neutral: This indicator began last week at 97% Oversold. Here is a quote from last week’s update: An “oversold (bullish) reading of 95% or higher is considered to be an extreme level. This is a very short term indicator. It will not take much of a bounce in the market to move back to a Neutral reading.”


Big Week for Equities:

  Last Week
Week of 11/16 to 11/20
Two Weeks Ago
Week of 11/9 to 11/13
S&P 500 +2.18% -3.59% -1.41%
Dow Jones Industrial Ave. +2.28% -3.35% -1.07%
Russell 2000 (small cap.) +1.79% -3.66% -1.87%
Canterbury (model portfolio) +0.51% -0.20% +0.31%

Source: Orion


How do I know if I am making money or not?

We only make money when our portfolio registers a new peak in value.


How do I know if I get to keep the money I make?

As long as the markets remain in Transitional and Bearish Market States, you will most likely not keep your gains. Furthermore, there is no reason to believe that you will not actually lose part of your principal.


Key concepts investors must understand:

  1. Bull Market States have less risk than Bear Market States.
  1. The portfolio’s holdings must adjust to maintain a “bullish portfolio” regardless of the existing market environment. All traded markets and securities will experience both bull and bear periods. The objective of the Portfolio Thermostat is to systematically and objectively adjust the portfolio’s securities to maintain a Bullish “Portfolio State” (Portfolio States 1, 2, 3, 4 or 5) even though most general asset classes are experiencing bearish market environments.
  1. Understand “systemic/market risk.”
    1. Systematic risk is known as “undiversifiable risk.”
    2. Systematic risk is unpredictable, random, and impossible to avoid.
    3. Systematic risk is greater during bearish than bullish Market States.

A normal “bull market correction” is defined as a 10% decline from the peak. Therefore, the “systematic risk” during a bull market is typically in the 8% to 12% range. A bear market is defined as a 20% or greater decline from the peak. During bear markets, many major indexes have experienced systematic risk as high as 50% to 80% declines from their peaks.

  1. It is important to understand that markets do not operate on a calendar basis. Markets don’t know that they should be higher at the end of every month or that each quarter should see gains between 2% to 3% so that the average annual return can be in the 8% to 12% range that investors expect.

What a Difference a Few Days can Make:

  • Let’s look a little deeper into October’s record month. Here are the numbers:

October 2015

9/30 through 10/30 (22 trading days)
S&P 500:                                            10.51%
Russell 2000:                                      7.27%
70% S&P and 30% Treas. Notes:    7.12%


What if the month of October began, and ended, one day earlier? The S&P 500 would have been up even more:

9/29 through 10/29 (22 trading days)
 S&P 500                                        11.19%.
The year’s expected return could have been accomplished in just one month!


What if October had begun and ended about two weeks earlier?

9/16 through 10/14 (20 trading days)
S&P 500                                          0.97% 
Wow, what a difference in two weeks!


What if October had begun about two weeks later?

10/12 through 11/14 (24 trading days)
S&P 500                                         0.60%
Moving backwards, or forward, about two weeks would have resulted in a 10.59% variation in returns.



So which return is the right one? Unless you cashed out of your portfolio, none of the values are especially meaningful. The short-term, double-digit fluctuations in the markets are typical of Transitional/Bear Market States. Therefore, whether a market is up or down, Transitional/Bearish environments are of little consequence because they are subject to unbridled, unmanaged, and random systematic risk.


The market environment made a dramatic shift from bull to bear in just two trading days:

8/19 Bull - Market State 2
8/20 Transitional - Market State 6
8/21 Transitional /Bear - Market State 12A


The Portfolio Thermostat quickly adjusted its holdings to meet its primary goals which is to limit the maximum peak to trough decline (drawdown from 8% to 10% with rare outliers of 12%).


The maximum declines from the May 20th peak to the August 25th bottom were as follow:

Maximum (drawdown) decline:
Canterbury Portfolio Thermostat:          -9.45%
70% S&P/30% T. Notes:                             -8.01%
S&P 500                                                      -11.75%


Risk Statistics (August 31st through November 23rd):


Canterbury Portfolio Thermostat:

Standard Deviation                                      1.96
Max. Drawdown                                         -1.93%
  70% S&P/30% T. Notes: Standard Deviation                                         11.81
Max. Drawdown                                           -3.68%
  S&P 500 Standard Deviation                                         16.85
Max. Drawdown                                           -5.64%

Source: Orion


Bottom Line:

The markets remain in a Bearish /Transitional Market State. The systemic risk is high. That said volatility can work both ways. It is not uncommon to experience short term kick-back rallies like October. Until the market moves back into a bullish Market State, the fluctuations (up and down) are considered to be random noise.

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.