Should We Worry About Event Risk In Bull Markets

Should We Worry About Event Risk In Bull Markets

Posted on July 06, 2015

Weekly Update

July 6, 2015

Market State 2 (4 trading days) Long Term: Bullish – Short term: Bullish/Neutral

Canterbury Volatility Index (CVI)*: CVI 54 – The CVI volatility shot up 7 points from the close on the previous Friday (a 15 percent increase) to CVI 56. The volatility increase was due to a sharp decline in the equity markets on Monday. The following two days saw a 2 point decline to CVI 54.

*The CVI is calculated on the S&P 500’s trade data. A CVI 75 or lower is considered to be reflective of a rational/low risk market environment for global equities in general.

The Overbought/Oversold indicator is at 78% Oversold (short term neutral). For reference, 95% Oversold or higher would be considered an extreme level (bullish).

Recap:

Last Monday the Dow dropped 350 points and the S&P 500 declined 40 points (about 2%). According to many experts, the sharp decline was caused by a negative turn in the Greek debt situation. Apparently, the Greek crisis wasn’t a real crisis until Monday.

The question is…why did the Dow decline 350 points? Why not 200 points or 450 points? Over the next two days, the Dow and S&P 500 gained back approximately half of Monday’s loss. So does that mean the Greek crisis was halfway fixed over those two days?

Of course not. The fact of the matter is that short-term news creates short-term market noise and noise scares people. People are always trying to connect the dots, attempting to use their reasoning skills to figure out why the markets do what they do. Bull markets simply have instances of normal pullbacks and corrections. Periods of extremely low volatility tend to be subject to a surprise one-day movement in the 2% range, either up or down. The current market activity is normal for the type of environment we have been experiencing for the last 12 months.

Recall this quote from last week’s update (June 29th): “CVI 49 – We are in a market environment with extremely low volatility. As a point of reference, only 79 trading days have seen volatility lower than the current CVI 49 since the beginning of the current Bull market in 2009. It is important to note that periods of extremely low volatility are subject to a ‘one day outlier’ of 200 to 300 Dow points. Such moves are normal and typically connected to an event, like the situation in Greece.” Such outliers “typically do not lead to a change in the market environment.”

Market Comment:

A recent Canterbury study on the US stock market index revealed some interesting statistics regarding how markets behave. We found that 59.53% of the trading days studied qualified as being in Bull Market States. The study covered the period from 7/23/1929 to 5/29/2015, spanning a total of 21,563 trading days. When we categorized the trading days into the Portfolio Thermostat’s 12 Market States (5 Bullish, 4 Bearish, and 3 Transitional Market States), we found that 12,837 qualified as bullish. 70% of those bullish days were spent in what we call a “trading range,” which we define as an extended sideways period of movements within about an 8% to 12% range. In other words, according to our study, when the market is in a “trending” environment marked by a series of higher highs and higher lows in price value, most of the profits are made during roughly 30% of the bullish market state days.

The current “trading range” market environment began on July 3, 2014 and is now up 6.76% through last Friday. During that time, the S&P 500 has had several corrections, the largest being about -7.4%. The S&P 500 is up 0.87% year-to-date.

For now, the path of least resistance is most likely down. But do not be fooled. The current pullback is only down -2.23% from the June 23rd peak. If you put too much stock by the financial media, it feels like much more.

Bottom Line:

Bull markets spend more time going sideways than going up. The Portfolio Thermostat only holds ETFs that are in bullish Market States, which means our portfolio too will have periods of sideways trading ranges and will experience normal bull market corrections. It will, however, for the same reason also participate in substantial bull market advances when they occur.

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.