Managing a Whipsaw is Tricky

Managing a Whipsaw is Tricky

Posted on December 01, 2014

Canterbury Portfolio Thermostat -Weekly Update- 12/01/2014

Market State 1 (23 Trading Days): Long-term (Bullish) Short-term (Bullish)

Canterbury Volatility Index is at CVI 55 (Bullish): Volatility, as measured by the CVI, continues to decline (Bullish). In fact, the entire month of November did not have a single day with an uptick in the CVI reading. The level of volatility on October 31st was at CVI 70 and the month of November ended at CVI 55 for a 21% decrease in volatility.

Overbought/Oversold "Oscillator” is currently 56% overbought (Short-term Neutral). This indicator went from an extreme 93% overbought (Bearish), two weeks ago, to the current 56% (Neutral) reading without a correction. The S&P 500 is up 28 points (a little less than 2%) over the last two weeks. It would normally require a period of backing and filling to consolidate past gains. That did not happen (very rare). 

Observation:

Figure 1: The S&P 500 continues to trade above its 5 day moving average for a record 29 consecutive days and counting. The old record, for consecutive days, was 22 straight, set about 60 years ago. The S&P 500 is up 10.42% from the October 15th low. As the old saying goes; “The trend is your friend.” 

It is interesting to note that the S&P 500 is up only 3.20% from its previous high on 9/19/14. This brings up a counter argument for those who say that the market is “medium term” over extended. The S&P 500 is up +13.98%, year to date. Look at the red line (CVI) at the bottom of the chart.  Notice the negative correlation between CVI volatility (moves opposite direction) and the S&P 500 index. 

High and increasing volatility is a Bear market characteristic. Low and decreasing volatility is associated with Bull market environments.

Managing Whipsaws:

Figure 1: The chart of the S&P 500 above is a good example of a whipsaw. In this case, there was a -7.4% sharp decline, followed by a rare V shaped bottom. Even rarer was the fast ascent back to new highs. What was not a surprise were many investors and portfolio managers’ actions. The capitulation is marked at the bottom on October 15th.  The S&P 500 ETF (symbol SPY) had its highest volume day since 2011. Portfolio managers and investors “threw in the towel” at the bottom and have been chasing the market up ever since. In other words, they got “whipsawed.”

Being on the wrong side of a whipsaw is one of the worst portfolio management mistakes one can make. An investor would suffer a sharp decline in value (drawdown) and would miss out on the advance. A whipsaw is difficult to navigate because they are counterintuitive. Investors and portfolio managers feel like “all is calm” at the peak. Then their feelings of “fear” becomes “panic” at the bottom SELL! The market hits the bottom then begins its ascent, there is a feeling of “regret.” I better buy back in or I will look bad holding cash. The other option would be to wait for a correction and then invest the cash. What if there is no correction?  Then I will look bad holding cash or short term Treasuries. Finally the “window dressing” begins as managers, who missed out, will then invest so it doesn’t “appear” that they did not totally miss the advance. Window dressing could be a source of buying through December.

Observation:

Fiqure 2: The Line graph below compares 5 major market indexes in order of year to date in order of returns: 1) S&P 500; 2) Dow Jones Industrial Average; 3) Emerging Markets Index; 4) Russell 2000; 5) EAFE (Europe, Asia and Far East).

The line graph above compares the daily price changes for the 5 major market indexes. The returns range from over +13% to about (-3%). It is interesting to note, all 5 indexes had Bull Market characteristics on June 30th but just two are higher today, one index is about the same and 2 are actually lower. My point is, it would have been difficult, if not impossible, to determine which would have been the better performers on June 30th. 

Quote from last week’s update: “Bull Market environments are more predictive of the risk of draw-down than they are for the amount to total “upside” returns. The draw-down risk is predictable during low volatile Bull market environments. A normal Bull market pullback or correction is -5% to -10%. We also know that the most meaningful market advances occur during Bull market environments. The amount of upside returns and timing of those returns are difficult to predict. 

We do not know how long a Bull market environment will stay intact, when and how many times the leadership among the various asset classes will change or how strong the Bullish trends will be in the future.” How many experts would have predicted that the S&P 500 would have been up over 30% in 2013?

The Portfolio Thermostat’s rules based model negotiated the trickiest whipsaw since 2011. Our portfolio is up 4.64% net, for the 4th quarter to date. 

The Portfolio Thermostat’s algorithms show evidence that Bull and Bear market environments can be identified and managed. Normal “Bull market corrections,” that become whipsaws can be identified, with high probability, versus the early stages of a Bear market. 

Bottom Line:

Traded securities are liquid. Their prices are determined by the law of supply and demand in the market place. Therefore, all traded markets and securities will fluctuate in price and they will experience both, Bull and Bear markets.

Know the difference between a Bull and Bear market, as defined by the Portfolio Thermostat’s Market States. Only hold securities that are in Bull Security States.

Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom Hardin, Chartered Market Technician (CMT), 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.