Volatility-You Can Observe a lot by Watching- Yogi Berra

Volatility-You Can Observe a lot by Watching- Yogi Berra

Posted on November 02, 2011

Picture yourself, standing in front of an elevator, on the 30th floor, in a 60 story building. There is a sign on the door that says, "This elevator is VOLATILE and will surge up and plunge down at any time." "Enter at your own risk." Would you get on?

Markets tend to vacillate between two extremes ranging rational to irrational. As a result, the stock market’s volatility will increase and decrease depending on the emotional state of the majority of market participants.

We have been riding the “volatile elevator” beginning on 8/4/11. Fortunately we knew the date when the market shifted from being rational (stable) to irrational (volatile). We knew the market would remain volatile and we know what needs to occur for the market to return to a rational (stable) environment.

Our Canterbury Volatility Index (CVI) measures the market’s volatility or emotional state. A CVI reading below 90 reflects a stable or rational market. A CVI above 90 reflects an emotional market. On 8/4/11 our Canterbury Volatility Index CVI increased from 78 (rational) to 104 (emotional).

The S&P 500’s CVI peaked at 171 on 8/18/11, Bonkers Irrational. Irrational market environments are volatile and will fluctuate both up and down. Today, the Canterbury Volatility Index is 155 and continues to be irrational.

Dynamic markets require a disciplined scientific process to identify the current market environment and to make portfolio adjustments.

Our Portfolio Thermostat Matrix helps maintain stability by identifying the current market environment or Market State. The Thermostat Matrix process reflects 12 different Market States. We have 6 Bullish Market States, 4 States are Bearish, and 2 States tend to precede transition meaning caution.

Currently, the Thermostat Matrix is in Market State 11. Market State 11 means the long term trend is Bearish, volatility is high and short term technical indicators are positive but can turn negative quickly.

Market State 11 will plunge and surge. The high volatility is associated with a bear market or a short term bubble. MS 11 is a challenging and emotional environment that drives Wall Street and investors nuts.

Let’s put the October surge in perspective. The S&P 500 was up +16.86% over 19 days ending 10/27/11. The rally was preceded by a decline of -9.60% over 11 trading days. Thursday’s +340 point gain in the Dow has now been negated by the -576 point decline over the last two days. Yesterday's (11/2/11) S&P 500 close 1218 is down -3.33% from day before all this craziness began on 8/3/11.

Big advances (surges) are normal during volatile Bear markets. The 2008 Bear market saw a +19% surge in just 6 trading days. The 2000-2003 Bear market had a +24% rally over 22 trading days in 2002. There were many more double digit percentage rallies that were quickly followed by new lows.

What can we learn from the current craziness? Don’t get on the “volatile elevator.” It is much safer and less stressful to ride the “stable elevator.”

The masses are again getting caught up in the market and media noise and, like in the past, will do the wrong thing at the wrong time. The truth is traditional diversification does little to reduce risk when markets are emotional. If it did work, then investor’s portfolios would not be so volatile.

The primary objective, during irrational markets, is to maintain stability in our portfolios. All markets get irrational from time to time. This too will pass. Markets have historically spent much more time in the rational mode as compared to the rare current irrational market environment we have been experiencing.

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.

Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom Hardin, Chartered Market Technician (CMT), makes all the final decisions on all investment and portfolio management decisions for Canterbury Investment Management. Tom has more than 30 years experience in the investment management industry and has broad breadth of knowledge. He is known as an innovator, educator and been revolutionary in the advancements in portfolio and risk management.