Complacency Remains High and Volatility is Low

Complacency Remains High and Volatility is Low

Posted on December 09, 2013

Canterbury Portfolio Thermostat - Weekly Update-12/09/2013

Current Market Environment - Market State 2 (last 2 trading days): Market State 2 is indicative of a normal correction, or period of price consolidation, during a long term Bull market. The current market environment is more reflective of a sideways "consolidation” than the expected -4% to -8% correction that is more typical of Market State 2.

Canterbury Volatility Index (CVI) = 50 (reflects a rational market environment) The CVI finished 1 point lower for the week. It is interesting to note that the market declined 5 days in a row and the volatility actually decreased to a new low of CVI 48. As a point of reference, a CVI reading below 75 is considered to be a "safe zone.”

Volatility typically increases when the market goes down. The volatility kicked up 2 points when the S&P 500 spiked up 1.12% on Friday. The current volatility feels more like Market State 1 than Market State 2.

Market Comment:
The peak on the S&P 500 was registered on Wednesday November 29th at 1807.23. The maximum decline from the peak was registered last Thursday at 1785.03 for a decline of -1.24%. Friday’s rally got us to within one point from a new high. Our overbought/oversold indicator dramatically improved from 62% overbought (Neutral) to 71% oversold (slightly bullish).

Last Friday’s 198.68 point advance, on the Dow Jones Industrial Average, was NOT unexpected. I have discussed, in previous updates, the "isolated” 200 to 275 point one-day advance or decline that seems to come out of nowhere. Such a day is most likely to occur when complacency is high and volatility is low. This was definitely the case prior to Friday. We were coming off a relatively long period in Market State 1 (32 trading days), and during that time the maximum market correction was only about -1.2% and the market has had record low volatility.

Please be aware that the market conditions remain right for another potential isolated 200 to 275 point day on the Dow. If such a move occurs on the downside, it would be considered a normal event (market noise) and would have no meaningful affect on the current Bullish market environment.

Portfolio Thermostat Market States:
The Portfolio Thermostat process identifies 12 individual Market States which are comprised of:

  • 6 Bullish (rational) Market States
  • 4 Bearish (irrational) Market States
  • 2 Transitional Market States (which tend to precede a change from Bullish to Bearish, indicating caution)

Market States are categorized by analyzing three primary inputs:

  • Long-term indicators are used to identify the primary trend of the market or security.
  • The proprietary Canterbury Volatility Index (CVI) and related volatility indicators evaluate the degree of rationality in the current market environment.
  • Short-term supply and demand indicators determine which portfolio adjustments are to be made and indicate the strength of the current Market State.

Canterbury Market State Study:
Canterbury performed an extensive study on the primary US stock market index in 2011. Our analysis was based on market data covering 20,516 trading days over the period from 7/19/1929 though 3/31/2011.

The study began by defining and identifying every market environment's ranging from the rational low volatile "Bull Markets” to irrational and highly volatile "Bear Markets” and Bubbles. The Portfolio Thermostat model was able to isolate the 12 individual Market States (meaning different market environments)

The Portfolio Thermostat Model then analyzed the expected order (sequence) of the changes from one Market State to another, the various unique characteristics of each market environment, the average longevity, the variations in the volatility and the impact on future market price action.

Market State Study Observations - Market States 1 and 2:
Market States 1 and 2 were, by far, the most common of the twelve defined environments. Market States 1 and 2 account for 35.89% and 17.65% of the total trading days respectively (53.54% of total days). Most, short term, market cycle high’s occurred while in Market State 1. The normal correction, or consolidation, following the new short term high, could cause a shift from MS 1 to MS 2. Long term Bull markets are marked by frequent shifting, back and forth between Market States 1 and 2.

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.

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.