Hold Your Ears and Don't Listen to the Noise

Hold Your Ears and Don't Listen to the Noise

Posted on December 11, 2018
Market State: MS 6 Transitional: The S&P 500 stock market remains in a transitional market environment characterized by the higher degree of emotion that we have seen over the last few weeks.

Canterbury Volatility Index (CVI)- CVI 101: Volatility is currently at CVI level 101, which can be expected when in a transitional/emotional environment.  There have been about 16 trading days, both up and down, that would qualify as an “outlier day” (+/-1.5%) since October the 10th.  Given this range of emotion, the market still falls within the realm of a normal bull market correction.

Definitions:
Our Analytics Group has performed extensive studies on how accurately the Canterbury Market States are at predicting the risk levels in the markets and in portfolios. Canterbury has identified 12 Market State environments. The 12 can be grouped into 3 macro environments:
  1. Bullish Market States - Efficient
  2. Transitional Market States - Short-term Inefficient
  3. Bearish Market StatesInefficient
Risk Terminology:
Risk is primarily defined as the maximum percentage decline (trough) from the previous highest “peak” value (also called “drawdown’).
 
Bullish/Efficient
  1. “Pullback” Decline of -5% or less from the previous peak value.
  2. “Correction” Decline from -8% to -12% from the previous highest peak in value.
Transitional/Bearish - Inefficient
  1. Unacceptable/Failure = -15% or greater decline from the peak
 
The Market is 97% oversold (declined too far too fast). A reading of 95% or higher means that a bounce is likely and should occur soon. The 50-day moving average crossed below the 200 day moving average to form, what is called a “Death Cross.” Sounds scary, but a Death Cross also formed on 1/11/16, 8/28/15, 8/12/15, 8/12/11, and 7/2/10 and the market went back up in short order.
 
I would like to quote my good friend and world class market technician, David Vomund:
1. The S&P 500 and Nasdaq Composite are at the lower end of a two month trading range. The support level isn’t super strong but the S&P 500 is close to support.
2. The Nasdaq’s weekly relative strength indicator (RSMD SPX) is still falling and on a sell signal, but the daily indicator is rising so it might be that a buy signal on the weekly chart is near.
3. Currently 97% of the stocks giving unconfirmed AIQ signals are on the buy side. This is a short-term signal but I’ll always lean toward buying when it is nearly 100% buys and I will al-ways lean toward taking profits when it is nearly 100% sell signals.
 
Fundamentally, the economy and earnings are slowing but we knew that would happen. It’s still growing, even if GDP drops back to the 2% growth that we’ve grown accustomed to. The market’s PE is at its historical average. Long-term interest rates are flat and I believe the Fed will be data dependent instead of blindly rising rates again-and-again. The problem is tariffs. Maybe we’ll win the “war” in a few years but right now the market doesn’t like Tariff Man’s actions.
 
 
Summary:
The most recent S&P 500’s maximum decline (drawdown), is about -10.2%.  The maximum decline is measured from the highest peak value to the lowest trough value. The peak was on 9/20/18 at 2931 and the trough was on 12/7/18 at 2633.
 
A -10.2% decline falls within the range of a normal bull market correction (see above). Therefore, the current volatility and the amount of the correction is considered to be normal market noise based on the current Transitional - Market State environment.
 
The Anatomy of a Market Correction:
Market corrections occur about once a year. Most corrections begin following an extended period of efficient trading and low volatility. The lack of volatility leads investors to develop a feeling of complacency. Corrections usually start with one or two “outlier days,” of about -1.5% or greater decline.  These outliers tend to come when most would least expect.
 
The impact of a sudden spike in volatility will shock many investors. Some of these former complacent long-term investors, will shift 180 degrees and turn into nervous short-term pessimists ready to follow their gut feelings. The additional buying and selling, of these newly minted traders, will result in a further increase in volatility. In addition, the direction of the swings in price will become more and more counter intuitive. Those who allow their emotions to dictate their actions will get whipsawed. Their fear of losing will cause them to sell after sharp declines. On the other hand, when prices begin to rise, investors fear of missing out will eventually buy back, at much higher prices.
 
In the end, those investors who allow their short-term emotion to dictate their investment decisions will scratch their collective heads and ask themselves why they continue to fall for the markets’ oldest, and arguably best trick. The trick of getting investors to make bad decisions by stirring up their emotions. We call it, the classic “market correction.”
 
Market corrections can experience large daily fluctuations, as much as +/- 3% or 4%. Most of these large outlier days are followed by more outliers, but generally the opposite direction. The alternating (up and down) nature of these large outliers are why most “corrections” are limited to about -8% to -12%.
 
The following is a recap of the recent market action. The percentage ups and downs begin on last Friday and move backwards.
Previous:
 6 Days = -6.0%
 4 Days = +3.0%
 9 Days = -6.0%
 7 Days = +6.6%
11 Days = -6.4%
 6 Days = +6.0%
 3 Days = -5.6%
Year to Date S&P 500 Return: = -1.3%
 
Chart A: Outlier days occur in both directions – up and down.
The S&P 500 is locked into about a 7% range over the last couple months.



Chart B: Earlier this year, the market experienced a period similar to the one we are seeing now. The market stabilized after 3 or 4 months.



Canterbury’s studies have shown that the S&P 500 has experienced 43 “corrections” (decline of -8% or greater) while in a Bullish/ Efficient Market State or a Transitional Market State. The studies show that 76% of these “corrections” return to a stable Bullish – Market State environment and last for about three to four months, on average, before stabilizing, and moving back to new highs.  Only 15 cases eventually converted to a Bearish/Inefficient Market State and with it, an unacceptable -15% plus decline.
 
Bottom Line:
The current market volatility is just noise. Most of it is caused by trading algorithms reacting to daily news stories. Noise is soon forgotten and has little impact on our primary objective. The goal is to achieve long term compounded returns by limiting portfolio risk to a normal correction of 8% to 12% and participating in the upside potential of financial markets.
 
As it stands today, the current market action is normal for a “Transitional” environment. The Canterbury Portfolio Thermostat Adaptive methodology continues to adjust to the new market environment. The portfolio is meeting its risk objective and is actually benefiting from the recent volatility. If the market shifts to one of the Bearish/Inefficient Market State environments, then further adjustments will be made.
 
Just Announced:
PSN, the oldest reporting service for Separate Managed Accounts and Mutual Funds had the Canterbury Portfolio Thermostat ranked in the top 5 World Allocation category for the 3rd Quarter.


 
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.