Can the S&P 500 Breakout of Its Trading Range?

Can the S&P 500 Breakout of Its Trading Range?

Posted on May 18, 2015

Canterbury Portfolio Thermostat™

Weekly Update

5/17/2015

Market State 2: Long-term: Bullish; Medium-term: Bullish; Short-term: Neutral. The market has made no meaningful progress in shifting out of this year’s lethargic trading range. That said we are likely to see a change in the market’s behavior in short order. This will be further discussed in the Market Comment below.

 

Market State™ (calculated on the S&P 500). Current Macro Environment for Equities. The

Portfolio Thermostat identifies 12 different market environments called “Market States.” Each Market State has its own unique characteristics and tendencies. The Macro- Market States are used to provide a “big picture” view of the characteristics of the current equity markets. The S&P 500 is commonly referred to as “the market.” There are 5 Bullish (rational – low volatility) Market States; 4 Bearish (volatile and/or increasing volatility) Market States; 3 Transitional Market States (indicating caution).

 

Canterbury Volatility Index (CVI): CVI 58 - The CVI (volatility) decreased by 2 points from the previous week. The market’s volatility has remained within a 5 point CVI trading range over the last 24 trading days and counting. When a low CVI is coupled with a tight trading range, the outcome can be similar to squeezing down a spring. The tighter and longer one squeezes, the bigger the pop when the spring is released.

As a point of reference, a CVI of 75, or lower, is considered to be a “safe zone.” Canterbury has performed numerous studies on the impact of volatility on markets and securities. Our studies have provided evidence showing that low and decreasing volatility is a primary characteristic of a Bullish market environment.

 

The Overbought/Oversold indicator finished the week at 78% Overbought. (short term: Neutral /Bearish). This indicator increased 36 points last week. A reading of 95% or higher would be considered to be an extreme level (short term Bearish).

 

Market Comment:

My favorite market newsletter writer and friend, David Vomund, at Vomund Investment Management, reminded me of a saying coined by market technician John Bollinger.

 

David quoted John Bollinger by saying that “trendlines should be drawn with a thick Sharpie instead of fine-point pen.” The point is that a bullish “breakout” occurs as more of a “price range” rather than a specific point on a line. Please see the top right part of the chart below. The trendline is the point where an increase in price meets “resistance.”

On Thursday and Friday, the S&P 500 closes slightly broke above resistance at 2018, and established a new high by about 2 points. That said last week’s move higher was not enough to decisively breakout of the markets narrow trading range.

 

There are two likely scenarios from here.

  1.  We have one or two strong up days, along with heavy volume, breaking out of the current trading range. Such a move could cause a short term buying panic as investors cover short positions while others chase the market higher.
  2. The market fails to breakout. In this case the most likely next move would be to the downside and possibly retest old support at around 2085 or possibly the 2040 area.
  

Observation:

The “macro” - Market State is based on the S&P 500 index which tends to give an indication of the health of the overall global equity markets. It is important to keep three key points in mind regarding macro - Market States:

  1. It is possible for the S&P 500 to be in one of the 5 bullish Market States while, at the same time, other domestic or international equities are in Bearish - Market States. A rising tide does not always lift all ships.
  2. Bull markets are more about the predictability of the downside risk than the potential for upside gains. In other words, the definition of a “bull market correction” is a 10% decline. This means that a market or security can decline in the 10% range, from its peak value, at any time based solely on the shifting nature between supply and demand (market noise).
  3. Each of the 12 Portfolio Thermostat’s Market States is assigned specific percentage allocations to be distributed among global equity ETFs as well as alternative ETFs; i.e. bonds, commodities, real estate, etc.
 

Bottom Line:

All traded markets and securities will experience the three major market environments: Bullish, Transitional and Bearish. The primary objective of the Portfolio Thermostat is to maintain a portfolio of 10 to 14 ETFs that are in Bullish Market States.

 

Markets are dynamic and ever-changing. Therefore, effective portfolio management strategy requires a defined, rules based process. Such a process is designed to make timely adjustments in ETF holdings for the purpose of maintaining an efficient portfolio to match and move in concert with the changing market environments.

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.