Volatility is Now More Reflective of a Bull Market

Volatility is Now More Reflective of a Bull Market

Posted on September 26, 2016
Weekly Update
Market State 2: Bullish: Market State 2 represents a long term bullish environment with low market volatility. Bull markets are known for low and predictable risk.

Canterbury Volatility Index (CVI 60): Volatility below CVI 75 is considered to be in the “safe zone” (meaning that short term declines should not exceed a normal bull market correction of about -10% from the previous peak in value). 
Volatility, as measured by the CVI, can provide a reliable indication of market efficiency (the current benefit of diversification). Low and/or decreasing volatility indicates that the diversification among the securities (stocks) within the index (S&P 500) are moving independently to produce an efficiently traded market and thus reducing risk. On the other hand, a high and/or increasing CVI would reflect a high correlation among the index’s stock holdings (moving up and down together) and would be reflective of a low benefit of diversification and an inefficient market environment.

Canterbury’s studies show that there is an optimal range of volatility that is likely to produce a low risk environment. We have found that volatility within a range of CVI 75, on the high side, and CVI 50, or less, on the low side is optimal. In other words, volatility can obviously be too high but can also be too low. Extreme low volatility can set up a 1.5% or greater one day outlier (up or down). Such moves seem to come out of nowhere.

A “Low Volatility Alert” occurs when volatility is sub-optimal by being too low. In many cases, extreme low volatility will precede an opposite period of (high volatility) which is a characteristic of a bearish turn in the market.

The point of this discussion is to point out the fact that our volatility indicators were reflecting a sub-optimal period (volatility too low) market environment back in August that resulted in a short term spike in volatility. 

Source: AIQ
​Excerpt from the Weekly Update 8/23/16:
Volatility Can Move From One Extreme to Another
Canterbury’s studies show that volatility is likely to experience  certain times of extremes, with periods of very high volatility often followed by periods of very low volatility and vice versa. The current CVI of 54 is only one point off of the volatility reading (of 53) that was registered approximately this time last year. Last year, the low volatility reading was followed by a sharp decline a few weeks later.

The low volatility period played out as expected with a S&P 500 one day outlier of -2.5% followed by a +1.44% day and a -1.35% day. The market has now stabilized and has thus returned to bullish Market State 2 following a short stint in a temporary Market State 6 – Transitional. Please note that a “Transitional” Market State did not require a change in the portfolio’s allocations but does allow for a higher percentage of ETFs that are alternative (not correlated) to global equities.
Market Comment:
Most major equity market indexes finished the week slightly up: S&P 500 +1.2%; Dow Jones Industrial +0.8%; NASDAQ +1.2%.
Source: Bloomberg
The S&P 500 has rallied back to within 0.6% of its August 15th high water mark on the close last Thursday. Friday’s selloff was normal as the market is backing and filling by consolidating the rebound from the low on August 14.  Currently the market is neither overbought nor oversold (neutral).  The breadth of the advancing stocks verses declining stocks (advance/decline line) remains positive. The small cap Russell 2000 Index as well as the NASDAQ Index continue to outperform the large cap S&P 500 Index. Which is another bullish sign.
Bottom Line:
Bull markets are not known for going straight up. They tend to go up in spurts, when most investors would least expect. This is the nature of supply and demand which is a reflection of human behavior. As it stands now, pull backs should be limited in terms of scope and time, as most equity markets could begin their upward climb.
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.