The Generals are in Retreat // February 8, 2016

The Generals are in Retreat // February 8, 2016

Posted on February 08, 2016

Weekly Update
2/8/2016

Market State 12A - Transitional/Bear: The Portfolio Thermostat has been in one of the “Transitional/Bearish” Market States for the last 106 trading days, ever since August 20, 2015 when the Portfolio Thermostat shifted to Transitional - Market State 6. The next day (August 21, 2015), the market environment moved to Transitional/Bearish Market State 12A.

Canterbury Volatility Index (CVI 100 - Bearish): A volatility reading of CVI 75 or lower is reflective of an efficiently traded, low-risk market environment. Canterbury’s studies show that the risk, in a low-volatility environment, is typically limited to a normal “bull market correction” in the 8% to 12% range. Volatility readings between CVI 75 and CVI 90, when combined with a declining trend in volatility, is considered to be Neutral.

Currently, the major equity market indices are experiencing high and increasing volatility. High volatility means that stocks are experiencing higher correlation (increasingly moving together) and the benefits of diversification are diminishing. The current high and increasing volatility is a primary Bear market characteristic.

Overbought/Oversold Indicator (78% overbought - Short Term: Neutral/Bearish): I would have guessed that last week’s drop of -3.1% in the S&P 500 and the sharp decline of -5.4% in the NASDAQ would have been enough to turn this indicator to short-term oversold (bullish). Much to my surprise, this indicator remained virtually unchanged (bearish) from the previous week. This is why we rely on objective rules-based processes like the Portfolio Thermostat. There is no room for “subjective” gut feelings or personal opinions in the management of today’s complex markets.

Recap from Canterbury Weekly Update (1/4/2016)

At the beginning of January, we noted that “the S&P 500’s leadership, during 2015, was very narrow. The 10 largest capitalized stocks were the big winners of 2015 but…the S&P 500, which is weighted toward the largest companies like the Big 10, can be a poor proxy for the broad market of stocks. They (the Big 10) were strong enough to mask the bear market that was more commonly experienced by most U.S. stocks during the past year.”

The breadth of the declines were actually much greater than many realized: “The Russell 3000 is a broad market index. It represents over 98% of the total market capitalization of U.S. stocks. At the close of 2015, 61.8% (or 1851) of the stocks in the Russell 3000 were down 15% or more from their 52-week highs. A “bear market” is defined as a 20% or larger decline from the peak. As of December 31st, 51.9% (1555 stocks) in the Russell 3000 have experienced a bear market 20% or greater decline.”

Canterbury’s first Weekly Update for 2016 wrapped up with this observation about the strength of the 10 largest U. S. capitalized stocks (the Generals), which were masking a bear market in most other global equities (the troops): “The newly coined ‘FANG’ Index (Facebook, Amazon, Netflix and Google) averaged a whopping 77.2% gain for 2015. Can you spell B-U-B-B-L-E? All parabolic advances and bubbles end the same way, with a pop! It is only a matter of time.”

Market Comment:

The troops (smaller stocks) had been retreating since the middle of 2015, leaving a few large cap Generals to hold the line. The fall of the mighty was inevitable and it didn’t take long. Now most stocks are in full retreat.

Last year’s two strongest FANG performers, Netflix (+139%) and Amazon (+122%), are now both down -21% year-to-date. Here are a few more notable 2015 high flyers that took it on the chin last week: Facebook (7.3%), Salesforce.com (14.5%), Carnival (10.6%), Starbucks (10.3%), Microsoft (8.9%), Nike B (7.7%), Home Depot (7.4%) and of course LinkedIn (43%).

Commentary from an early November 2015 Weekly Update:

“Sharp declines are typically followed by large kick-back rallies, like that of October. These kick-back rallies are typically soon offset by an emotional sell-off.

The rally (October) did not have the characteristics that are typical of a sustainable advance. The probabilities of retesting the old lows and establishing a new lower low is substantially more likely than the opposite (retesting the old S&P 500 high at 2131 on May 21st and establishing a new high), which would be highly unlikely based on the current Market environment.”

If we compare the progression of the S&P 500 in comparison to our Portfolio Thermostat model, we see that the Market State shifted from Bullish to Transitional/Bearish on August 20th and 21st of 2015. The portfolio shifted and made adjustments through September. October saw a bear market rally that was led by some of the market’s worse performers and proved to be a whipsaw that the Portfolio Thermostat clearly identified and avoided. The Portfolio has been able to hold about even through a very difficult market environment following the November 3rd peak.


Bottom Line:

Managing markets is an ongoing process. It is not a passive. “Buy, hold and rebalance” by definition cannot manage or protect against bear markets. The Portfolio Thermostat is built to adapt to the existing market environment. This has been a good period to show how evidence-based portfolio strategy has evolved.


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.

Disclaimer
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.