A/D Line Flattens while Large Caps and Technology Outperform

A/D Line Flattens while Large Caps and Technology Outperform

Posted on July 22, 2019


Market State 1: The S&P 500 remains in Market State 1, which is one of Canterbury’s five bullish market states. The S&P 500 has been in Market State 1 for 23 trading days. During that time, the S&P 500 has put in 7 new highs. Canterbury studies show that 85% of all new market highs occur in Market State 1. Keep in mind, the S&P 500 only measures the largest 500 US stocks. The Russell 2000, which measures small cap stocks, has only recently crossed into a Bullish Market State and still lags far behind the S&P 500 in overall relative strength. Typically, during bull markets, we would expect small caps to be leading large cap stocks. 

Canterbury Volatility Index (CVI)- CVI 54: Volatility continues to decrease and is now at CVI 54, which is approaching an extreme low level (CVI 45).  When volatility becomes squeezed down, it is similar to the effect of squeezing down a spring: you may see a spike in volatility.  Short-term volatility, as measured by the 10-day CVI, has already crossed into extreme low territory, at CVI 37.  It would not be uncommon to see an outlier day or two from here.  Outliers tend to occur on extreme low volatility while in Market State 1.

Comment
We have mentioned in the prior weeks that Large Cap equities (S&P 500) have been one of the strongest performers this year. One way to illustrate this is by comparing the total US stock market (using the Russell 3000) to the S&P 500 using relative strength. The chart below shows that during the drop in December, the broad market under-performed large cap stocks and outperformed large caps coming off the bottom, but have significantly under-performed for most of the year. This is primarily due to the under-performance of small cap equities. In other words, the US market has been primarily carried by Large cap stocks.


Source: AIQ

Advance Decline Line
We have also previously discussed the advance/decline line (A/D Line). The A/D Line shows the number of advancing stocks to declining stocks. We want to see the A/D Line put in higher highs with the overall market (positive confirmation). Recently, as the market put in a new high, the A/D line matched an old high. This is nothing to be alarmed about over the long-term. Should the A/D Line begin to fall while the market is putting in new highs, or the A/D line starts putting in lower lows while the market puts in higher lows, it would mean that while the heavier stocks are experiencing relative successes, many lighter weighted stocks are beginning to fall off. 2000 was a great example of a negative divergence between the S&P 500 and the 1500 stocks only index (pictured below).


Source: AIQ

Nasdaq Relative Strength
One positive indication for the stock market is the Nasdaq’s out-performance of the S&P 500 on a relative basis. The perception is that if the Nasdaq is outperforming the S&P 500, then investors are willing to take on more risk. The chart below shows that back in May, the Nasdaq was under-performing the S&P 500 during the market pullback but has been outperforming on a relative basis.


Source: AIQ

Portfolio Metrics
Since the Canterbury Portfolio Thermostat is an adaptive portfolio strategy, it does not benchmark itself against any individual equity index or fixed percentage equity/bond blends. One simple reason for this is that the portfolio can adapt to any market environment- bull or bear, and therefore adjust its allocations. A fixed index or fixed portfolio allocation will always remain the same, and therefore, during bear markets, will be exposed to high levels of volatility and high asset correlations.
To accommodate for this, Canterbury developed its own internal benchmarks. These benchmarks are Portfolio State, Volatility (CVI), and Benefit of Diversification. Those metrics are combined into one composite “Portfolio Efficiency Score.” If the Efficiency Score is between 70-100, the portfolio is considered efficient. The Canterbury Portfolio Thermostat aims to maintain an efficiency score above 70 throughout all market environments- bull or bear.

Current Portfolio Metrics:
Portfolio State: Bullish
Volatility: CVI 37
Benefit of Diversification: 40%
Portfolio Efficiency Score: 100

Bottom Line
The S&P 500 has had a nice (and very unlikely) run so far this year by coming off a low at the end of 2018. This run in the market has been somewhat exaggerated in that large cap equities have led the market. Small caps, on the other hand, have not performed nearly as well to start the year. This goes to show that all asset classes will have both times of out-performance and times of under-performance. It just so happens that large caps are currently leading.

The Advance/Decline Line has flattened out slightly, although it is nothing to be alarmed about. There is still not a negative divergence occurring, and even if there were, a negative divergence can take place for a long period of time before ever making a significant impact on the actual market (see 2000 as an example). This short-term flattening is just something to be aware of and could result in a short pullback since the market is near a peak. The Nasdaq is outperforming on a relative basis, which is a positive sign.

Making money in markets is not about which index you choose to buy and hold. A buy and hold strategy is a strategy based on luck and hope, and as many know from past experience, luck and hope are not good investment partners. In order to achieve the benefits of long-term compounded returns, investors require a disciplined, adaptive methodology, based on managing an efficient portfolio through all market environments- bull or bear.

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.