A Time to Own Bonds and a Time Not To

A Time to Own Bonds and a Time Not To

Posted on August 12, 2019


Market State 6 (Transitional)- The S&P 500 index remains in Market State 6.  Other indexes, such as the Nasdaq and Dow are also in Market State 6.  The EAFE (Europe, Australia, Asia and Far East) is currently also in Market State 6, but unlike US equities, is trading at the lower end of its range.  The Emerging Markets are in Market State 12. 

Canterbury defines Market States as being Bullish, Bearish, or Transitional.  Bullish markets are characterized by low risk; bear markets have high risk and rising volatility.  Transitional Market States can either have rising or falling volatility (depending on where they are coming from). The current transitional environment was caused by a spike in volatility.
 
Canterbury Volatility Index: CVI 70- The S&P 500 currently has a volatility reading of CVI 70.  The Canterbury Volatility Index (CVI) measures the volatility of any liquid traded security or index.  Two weeks ago, the volatility of the S&P 500 was sitting at CVI 51.  Last Monday’s volatility spike caused a sudden rise in CVI.  As markets and securities experience declining volatility towards extreme lows, a spike in volatility is common as the market or security relieves some pent-up pressure. 

Following the spike in CVI, the market needs to regain its footing and figure out exactly where it wants to be.  At this point, a few wide-ranging days, or single day outliers are possible.
 
Comment
All liquid-traded securities will experience both bull and bear markets.  There will be times when bonds are riskier than stocks, and times when small caps will be safer than treasuries.  This is because all securities that have liquidity are driven by the law of supply and demand. 

In recent months, 20-year treasuries have been one of the safest, and most profitable asset classes.  This has not always been the case.  Even though conventional wisdom has taught us that bonds are “conservative”, the chart below shows 20 Year treasuries (TLT) from July of 2016 through October of 2018.  During this time there was a -22% peak to trough drawdown in treasuries.  This certainly does not fit the definition of conservative.



During that same time, the “riskier” asset class, US small cap stocks (Russell 2000) showed low/declining volatility and was more conservative than bonds.



 
Now, if we fast forward to today, the last 10 months have shown a very different story.  The Russell 2000 has experienced a wide range of volatility, and has since entered a trading range, while 20-year treasuries have shown better bull market characteristics.



Looking at the total picture, there has both been a time to own each one of these index ETFs, and a time not to.  20 Year treasuries are just about back to the same point as where they started from in July of 2016 (no money has been made for that total period).  The Russell 2000 had previously run-up significantly, only to give much of it back and still be more than 10% off its October high.
 
Portfolio Management
This is why Portfolio Management is crucial.  A buy and hold strategy will eventually end the same way: with large drawdowns.  We have seen buy and hold strategies essentially experience many offsetting penalties.  The latter part of 2016 through October 2018 saw a bull market for many equities, and a bear market for some bonds.  Conversely, the time since then has seen a parabolic advance in bonds, while many equities saw a transitional period and trading anomaly.  For a buy and hold strategy, falling bonds have been offset by rising equities, and falling equities have been offset by rising bonds for these last few years.

Well, there have been many bear markets that have seen both falling equities and falling bonds. As volatility increases, correlations often become higher, and the benefit of diversification within a portfolio will decrease.  When this happens, a buy and hold strategy has the potential to experience significant drawdowns as it cannot adapt to changing market environments.  Investors will begin to wonder why their “conservative portfolio” has not been very conservative.

Bottom Line
The market still remains transitional for many equity classes.  Bonds, on the other hand, have looked very bullish.  One quick note on this, is that bonds have advanced significantly and are in a sort of parabolic rise, approaching the same resistance levels they were at back in July of 2016.  At this point, bonds could experience a bounce off resistance and pullback, but time will tell, and the Portfolio Thermostat will adjust.

Adaptive Portfolio Strategy is all about the ability to maintain efficiency through variable market environments. This means rotating to securities that show bullish characteristics and creating a properly diversified portfolio.  In investing, we do not know how long bullish characteristics will stay in place, nor what kind of returns the securities will generate.  We only know the risks. The goal of all investors is to compound returns.  This can only be achieved through limiting drawdowns to normal corrections and maintaining efficiency within a portfolio.
 
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.