Unexpected Events Impact Markets Less Than What Most Expect

Unexpected Events Impact Markets Less Than What Most Expect

Posted on November 07, 2016
Weekly Update
Market State 2: Bullish (32 days): Market State 2 represents a long term bullish environment.  The S&P 500 closed Friday at 2085.18 and has now broken an important support level, set at the June 9th high, of 2119. A decisive break below the 2120 area could signal a decline to the 2000 range seen on June 27th (see chart 1).
The S&P 500 is now down 4.8% from its August 15th high at 2190. We know that financial markets and securities cannot go up every day, in other words, markets fluctuate. The important thing to understand is the difference between normal/random market noise versus the types of market behavior that tend to precede a substantial decline or a bear market. This Weekly Update will explore some of the unique characteristics present in the current market environment.

Volatility Alert:
Canterbury Volatility Index (CVI 48) Volatility, as measured by the CVI, continues to decline and closed Friday at a new low. It is rare to see volatility remain at an extremely low level (below CVI 55) while the market is declining. More typically, the volatility would trend up when the market goes down.
Quote from last week’s update: 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. Please see chart 1.

Chart 1 - S&P 500: Extreme low volatility can result in sharp one day outliers.

Source: AIQ

Quote from the 10/17/16 Weekly Update: As discussed in previous Weekly Updates, extreme low volatility can sometimes be similar to squeezing down a spring. The result can be a sharp spike in volatility as the built up pressure is released. The probabilities of a one or two day outlier, meaning days up or down in the 2% range are likely if volatility continues to get squeezed down.
The Dow is up over 300 points +1.7%; S&P 500 is up +1.9% and the NASDAQ 100 is up +2.1%, as of the time of this writing on Monday, November 7th. The financial press will attribute the move to some event, most likely the election.
Our contention is that the market was due for a spike in price, regardless of the election or another short term event. Events don’t drive markets. Events only drive market noise. The amount of market noise is directly connected to the existing Bullish, Transitional or Bearish Market State. Single day moves, up or down, are rarely more than 1% to 1.5% while in a bull Market State. The exception is when volatility is below the optimum level, like today.

Market Comment:
My good friend and top market technician, David Vomund, had some interesting observations in his weekly newsletter called VIS Alert.
The following are some quotes from David’s work:
The S&P 500 has shed 3.1% in a nine-session decline. The last time it fell nine straight days ended December 11, 1980, when the index was down 9.4%.  While it’s been 36 years since this has happened, at one time it wasn’t as rare.  A nine-straight day decline occurred three times in the 1970s, five times in the 1960s, and one time in the 1950s.  How did the market perform after these periods?  On average, one month later the S&P 500 was flat.  If the market declines on Monday, then it will mark ten-straight down days.  Since 1950 that has only happened five times (7/29/75, 10/26/71, 11/24/69, 5/5/66, and 2/24/66).  One month after these occasions, the market was always lower with the average loss of 2.11%.  From this we see the decline is not an automatic buy signal.  The current technical picture aligns with this as well.  Even with the decline the market is far from oversold. The Nasdaq’s weekly relative strength indicator has turned lower.  More difficult market environments occur when this indicator is falling.   

The S&P 500’s performance is masking the shocking weakness in the traditionally safer dividend paying stocks.  Consider ProShares Dividend Aristocrats (NOBL), which holds stocks in the S&P 500 that have increased their dividend every year for 25 years.  This ETF is down 8.3% from its high. 
We continue to be stuck in a trading range. The market’s leadership continues to rotate from one sector to another.
Bonds performed well until July and are now down about -8% from the peak.

Source: AIQ

Bottom Line:
Dormant periods in the market are more the rule than the exception. The primary goal of the Portfolio Thermostat is to hold declines to normal bull market corrections (about 10%). On the other hand, the Portfolio Thermostat will also hold ETF securities that, as a group, have potential for substantial upside returns.
It is important to remember that risk management is critical over the long run and that most large advances occur during relatively short periods and when most would least expect it. We may be entering into one of those periods soon.

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.