Pullbacks and Rotations

Pullbacks and Rotations

Posted on June 10, 2019
Market State 6 (Transitional)– The current Market Environment, as measured by the S&P 500, remains in a Transitional Market State 6 and has been for the last 19 trading days.  The Market State 6 was initiated in mid-May following a spike in volatility (CVI). 
 
Canterbury Volatility Index (CVI): CVI 70- The Canterbury Volatility Index increased by 5 points last week, following 4 consecutive up days.  Volatility has been moderately increasing throughout the recent market pullback, which is something to be expected.  Since the change to a Transitional Market State 6, there has only been one velocity of volatility spike (CVI jump of 7 points or more) and that was on the day of the shift to a Transitional Market State 6.  Since then, there have been no additional spikes in CVI.
 
Comment
 
Markets do not understand the calendar.  They do not know that December 31st closes out the calendar year or that May 31st closes out the month.  The recent market pullback that occurred throughout the month of May was particularly coincidental.  It was coincidental in that the high for the month was its beginning value (the close of April 30th) and its low was May 31st.  The recent market pullback that occurred throughout the month of May has not been all that significant in the grand scheme of things. A 6% pullback from peak value still falls within the normal range of noise, especially considering that this recent pullback has yet to come with any considerable amount of added volatility. 
 
Now, a 6 or 7% pullback can feel extreme given the events of the year so far, but this does not yet make it any more significant than any other pullback during a Bullish or Transitional/Bullish environment. The start to 2019 has been interesting.  The calendar year essentially started at a market trough and trading anomaly.  December 2018 saw the quick, downward spiking trading anomaly, while the start to 2019 saw the snap-back rally. Since January 4th, 2019, when CVI was at its highest point, the largest market drawdown experienced was -2.2%.  That means there were 4 consecutive months (around 84 trading days) where the market did not see so much as a -3% drawdown.  The probabilities of that happening are extremely low.
 
Markets cannot consistently go up forever without experiencing pullbacks/drawdowns.  The month of May was an example to that.  A 6% pullback from a peak is normal.  It just feels different when the peak is at the start of the month and trough is at the end of the month, and there have been no signs of any pullbacks so far this year.  Just as May started off on a downward slide, the start of June has seen a kick-back.  Since June 3, the market has rebounded close to 5% (over the course of 5 trading days).  After falling close to 7% in the month of May, it is now pretty much at the same point it was one month ago.  In fact, if May would have started 6 days later and ended last Friday (May 7-June 7), the month would have been flat instead of down 6 or 7%.
 
Sector Rotation
 
One observation that has been consistent over the last few months, and even some years, is the inconsistency of sector leadership.  There have been many rotations among market leaders.  Sectors that outperform in one period, have underperformed in the next and vice versa.  The table below shows the changes in Volatility-Weighted-Relative-Strength, Canterbury’s proprietary ranking system which ranks securities on a risk-adjusted basis. The VWRS rank column under June 7 also shows the change in rank from the prior month.
 
VWRS Rankings Amongst S&P Sectors
June 7th, 2019 May 7th, 2019
Sector VWRS Rank Sector VWRS Rank
Real Estate 1 (+4) Technology 1
Staples 2 (+4) Discretionary 2
Utilities 3 (+4) Financials 3
Financials 4 (-1) Industrials 4
Technology 5 (-4) Real Estate 5
Basic Materials 6 (+2) Staples 6
Industrials 7 (-3) Utilities 7
Discretionary 8 (-6) Basic Materials 8
Healthcare 9 (0) Healthcare 9
Energy 10 (0) Energy 10
 
The first thing we can notice with this table is that Real Estate, Staples, and Utilities all were previously floating in the middle of risk-adjusted strength and are each now showing leadership on a risk-adjusted basis.  Technology fell from being the top ranked sector to now middle-of-the-pack.  Discretionary took the hardest hit during the recent pullback falling from 2nd ranked to 8th ranked.  Healthcare and Energy remained the same.  Healthcare is primarily underperforming on a risk-adjusted basis due to poor performance from pharmaceuticals.
 
Bottom Line
 
Investing is a lifetime endeavor.  Investment success is not determined by the calendar.  The game is constantly continuing.  A single month pullback is nothing to be alarmed over.   Markets will fluctuate.  2019 started off with a large run coming off the bottom of a trading anomaly.  We did not experience so much as a 3% drawdown during that time. The month of May saw a 6-7% pullback, most of which has been corrected during the start of this month. In addition, there have been several rotations in leadership since the start the year, and even in the last month. 
 
An adaptive investment process, like the Portfolio Thermostat, is designed to navigate varying market environments over the course of the lifetime of your investments.  All asset classes, securities, and fixed allocation portfolios will go through both bull and bear markets. Each one of these can experience substantial, long-term drawdowns over the course of a lifetime.  The Portfolio Thermostat is designed to adapt its holdings to maintain efficiency through all market environments with the goal of limiting drawdowns and compounding returns.
   
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.

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