The Market Just Got Hit in the Face with a Cold Glass of Water

The Market Just Got Hit in the Face with a Cold Glass of Water

Posted on February 06, 2018
Periods of extremely low volatility almost always end the same way. Big one-day outliers occur when most would least expect.
 
I have used the the old “squeezing the spring” analogy so many times that you are probably as tired of hearing it, as I am using it.
 
When the trading range gets really… really tight, and it stays tight for an extended period of time, it can be like shooting someone out of a spring-loaded cannon. The problem is that you are never sure when it is going to shoot, which way, and how far.
 
Well... the pressure has now officially been released. The sleepy market has been hit in the face with a cold glass of water. Right now, the market doesn’t know where it is, or where it is supposed to be. It will take a few days to shake out and get back to normal market behavior.
 
Market State 6: Short-Term/Transitional/Long-Term Bullish (2 trading days): 
Market State 6 represents a “Transitional” environment. In the current case, the market is transitioning from being over extended, in price, from a long period of extremely low volatility and very small corrections (largest correction has been less than -3% for over a year) to an oversold market (declined too far too fast) and higher than normal volatility. 
 
Canterbury Volatility Index (CVI 74):  Last Friday, the volatility shot up 9 points, from CVI 40 to CVI 49 and was followed by a 25 point spike yesterday. A spike in volatility of 7 points, or greater, will trigger a “volatility alert” in our Velocity of Volatility indicator. The alert will be cancelled when our short-term supply and demand indicators turn back positive.
 
Canterbury Analytics defines a one-day outlier as a move of 1.5% or greater. Last Tuesday, the S&P 500 was down -1.76%.  It closed Friday down -2.12% and yesterday, Monday 2/5/18, down -4.1%.
 
A bull market environment (like current one) is ALWAYS subject to a 5% to 10% decline, from the peak, at any time. These “pullbacks” or corrections, in the major market indexes, are RANDOM… which means unpredictable. This is a part of the small cost for liquidity.
 
Canterbury’s volatility algorithms will typically turn negative following an “extended” period of increasing volatility and a reading above CVI 75.  A normal bull market correction (10%) from the high is normal and expected.
 
Canterbury’s Study of Extremely Low Volatility
It is rare to experience extremely low volatility for a prolonged period.  Canterbury Analytics produced studies looking at daily data on the Dow going back to December 31, 1896. During that time, only 14.5% of the trading days qualified as extremely low volatility (CVI 45 or lower). Rarer still, are long periods of extremely low volatility; i.e., 200 consecutive days or longer.
 
The Dow Jones Industrial Average’s streak of volatility below CVI 45 and price above the 200-day moving average just ended last Friday (2/2/2018). This was the second longest streak, 278 trading days, since the beginning of our data set.
 
The following chart displays some interesting statistics on the 10 longest streaks when volatility was below CVI 45 with the price being above the 200-day moving average:
 
Chart 1: Price has pulled back to the trendline and the 2nd longest streak of extremely low volatility has ended.

Source: AIQ

The following are some interesting statistics on the 10 longest streaks when volatility was below CVI 45 and the price being above the 200-day moving average:

Chart 2: The maximum declines and run-up during long periods of extremely low volatility



Chart 3 shows the same 10 longest streaks, of extremely low volatility, as above. This time, it will show the maximum decline, from the peak, when the price is above the 200 day moving average but the volatility was at CVI 75 (not CVI 45) or lower.


*The number of trading days and maximum peak to trough decline during the period from 1/26/18 high through Monday 2/5/2018.
 
Observation:
Maximum declines (drawdowns) have been limited to normal, and random, bull market corrections (about -10% from the peak) when the price is above the 200 day moving average and volatility is at CVI75 or lower.
 
The Market is Now Extremely Oversold:
The Overbought/Oversold indicator is giving a rare 100% Oversold (Short Term Bullish). My colleague, David Vomund at Vomund Investment Management, refers to this indicator as a, “counter emotional indicator.” The indicator turns bullish at 95% oversold or higher.  In other words, when everyone is headed for the door and your emotions are telling you to sell, the reading is likely to be at 95% plus oversold. The current 100% reading would make this short-term indicator… bullish
Canterbury’s studies show that a transition from a bull to a bear market doesn’t happen overnight; it is a process that typically requires some time. A transitional phase is a period when the market has sold off enough to trigger several bearish indicators but, at the same time, the sell-off is likely to create an oversold market. An emotional “kick-back” rally is likely. The following rally can be as strong as the emotional prior sell-off.
 
Bottom Line:
We are still within the confines of a normal bull market correction of 8% to 10% with the potential of a rare 12% outlier.
 
Avoid listening to the media hype and getting caught up in the emotions of the masses. The market is in capitulation mode. A rally should occur sooner rather than later. It will take a period of time for the markets to complete a stabilization process. The Portfolio Thermostat is operating efficiently and will make the necessary adjustments as our indicators shift to reveal the new market environment.
 
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.