Market States

Market States

What is a Market State?
Identifying the macro stock market environment is the first step in the Canterbury Portfolio Thermostat Process. The Portfolio Thermostat process combines volatility and a combination of supply and demand indicators to identify the current state of market efficiency.  Using daily data, the system has been tested back to 1896 (32,000 data points) and confirmed 12 different Market State environments. They are categorized as:
  • 5 Bullish (rational) Market States
  • 4 Bearish (irrational) Market States
  • 3 Transitional Market States (which tend to precede a change from Bullish to Bearish, or vice versa, indicating caution)
 
3 Primary Inputs to Market States:
  • Long-Term Indicators: Identify the long-term status of the market or security.
  • The Canterbury Volatility Index (CVI): Evaluate the degree of rationality/efficiency of the current market environment. An “efficient market” environment is one that is marked by low or declining volatility. Efficient markets should have limited risk similar to a normal bull market correction, defined as a 10% decline from the peak value.
  • Short-Term Supply & Demand Indicators: Indicate the short-term directional movement of the current market.


Market State environments are not about the predictability of return, but rather the level the of risk that can be expected.  Each Market State environment exhibits its own unique characteristics, associated with a given risk.  Risk is defined as Volatility and Drawdown (the maximum decline from peak to trough). 
 
Bull Markets
  • Environment: Low Risk/Efficient
  • Market States 1,2,3,4 and 5
  • Volatility: Low/Decreasing
  • Supply & Demand: Positive
  • Expected Drawdown: 8-12%
 
Transitional Markets (from Bull to Bear)
  • Environment: Increasing Risk
  • Market State 6
  • Volatility: Rapid Increase
  • Supply & Demand: Negative
  • Expected Drawdown: High
 
Transitional Markets (from Bear to Bull)
  • Environment: High Risk
  • Market States 7 and 8
  • Volatility: High/Decreasing
  • Supply & Demand: Negative/Improve
  • Expected Drawdown: High
 
Bear Markets
  • Environment: High Risk/Inefficient
  • Market States 9, 10, 11, 12
  • Volatility: High
  • Supply & Demand: Negative
  • Expected Drawdown: Unlimited