Volatility Continues to Decline as Market nears Resistance

Volatility Continues to Decline as Market nears Resistance

Posted on September 23, 2019

Market State 2- Bullish: The US stock market’s recent rally, on declining volatility, has been enough to shift back to Market State 2.  The characteristics of Market State 2 are Long-Term: Positive; Volatility: declining; and Short-Term Supply & Demand: negative. 

The shift to Market State 2 comes after a Transitional environment that was caused by a spike in volatility back on August 5th.

One thing to note about Market States is that they are a measure of risk, not return. The combination of technical indicators that go into Market States are used to measure the risk levels of the market.  Market States are not designed to indicate expected returns, nor do we know how long a certain Market State Environment will stay in place.

The chart below shows the S&P 500 and its daily Market State from 2000 to present.  We can note that during bear (red) and transitional (yellow) markets, risk is much higher.  We also notice that most market “runs” occur in bull (green) Market States.  That being said, there have been many instances when transitional markets turn back bullish and are short lived, or bull markets only stay in place for a very short period.  There have also been bearish periods that ended positive for the market.  Market States are not a measure of what will happen but are a risk measure used to see what could happen.

Canterbury Volatility Index (CVI)- CVI 73: The Market’s volatility has been quieting down since the near bottom of the pullback and volatility high (CVI 87) on August 23rd.  The market giving a short rally, and flattening out, and lack of outlier days has caused volatility to begin to decline.  Now, volatility does remain towards the upper end of its recent range.  At the market’s last peak on July 30th, volatility was at a low point of CVI 51.  At the bottom of the pullback, volatility measured CVI 87.  Now that the market is sitting closer to that last peak, volatility remains much closer to its high point than its low point.

In addition, short-term volatility (a 10-day CVI) has fallen very far, very fast.  At its high point, short-term volatility measured CVI 138 on August 14th.  Since that point, short-term volatility has declined to CVI 38.  This puts short-term volatility at an extreme low level, and at a disparity compared to longer-term volatility.  From Canterbury’s studies, there have been 60 occurrences since 1950 when short-term volatility has been at an extreme low, and long-term volatility has been at least 30 points higher.  Of these 60 periods, all of them ended with an average of +/-1.00% day, with 31 of the periods ending with a -1.00% day and 29 of the periods ending in a +1.00%.  Extreme low volatility, like the volatility shown in the short-term CVI, is similar to the squeezing down of a spring—you may expect to see a “pop”.
Coupled with the transition to Market State 2 and a falling volatility, specifically short-term volatility entering extreme low territory, the S&P 500 is right up against resistance levels.  It is nearing the old high, and since doing so has been hovering this level, yet to show signs of wanting to break through. 

The chart below shows the S&P 500 with both longer-term and short-term volatility (CVI).  It also shows the current levels of the S&P 500 with some overhead resistance at the old high, where the market is now currently hovering.

Source: Amibroker

Portfolio Thermostat
The Canterbury Portfolio Thermostat does not aim to compete against any individual index or blended benchmark.  We know that portfolio efficiency is a moving target, and all asset classes will go in and out of favor.  The Portfolio Thermostat is an Adaptive Portfolio Strategy designed to navigate various markets and create an efficient portfolio for today’s environment- Bull or Bear.
Canterbury benchmarks its portfolio against key “internal” metrics, in order to measure portfolio efficiency.  These metrics are Portfolio State, Portfolio Volatility, and Portfolio Benefit of Diversification.  Together, these internal benchmarks create the Portfolio Efficiency Score.

The Portfolio Thermostat remains efficient following recent market movements. Volatility is low, while the Benefit of Diversification is higher to the market coming out of a transitional environment, yet to break through resistance levels.  The market has been flattening out and could experience an outlier day (up or down).  The Portfolio Thermostat’s current Portfolio Efficiency Score of 90 indicates that risk within the portfolio is low.

Bottom Line
The Market is now in Market State 2 as volatility continues to inch way down.  The declining volatility feels like it has been a rather slow process, but short-term volatility (a 10-day CVI) is at an extreme low.  The extreme low short-term volatility, along with the market being near a resistance level, could result in an outlier day.  Although the S&P 500 has entered Market State 2, we do not know how long these characteristics will stay in place.  The market may break through those upper resistance levels and continue to Market State 1, or we could go back and retest the old lows from mid-August.  Market States are a measure of where risk is right now, not how much return the market will generate, nor how much risk there will be next week.

The Portfolio Thermostat is currently positioned properly to deal with the current market environment, as indicated by the Portfolio Efficiency Score of 90.  Should the market retest old lows, the Portfolio Thermostat has a higher Benefit of Diversification, which should help stabilize the portfolio.  In addition to this, the Portfolio Thermostat holds many equities that are exhibiting low risk, bullish characteristics.
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.

Canterbury Investment Management: Tom Hardin

More About Brandon Bischof

Brandon is directly responsible for managing the Canterbury Analytics Group (CAG). To date, Canterbury Analytics Group has played an important role in advancing portfolio management from a loose art form based on subjectivity and obsolete assumptions to an adaptive process with scientific rules and methods capable of providing evidence based results and statistically relevant value add results.

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.