Transitional Market Environments: A Battle Composed of Many Skirmishes

Transitional Market Environments: A Battle Composed of Many Skirmishes

Posted on November 26, 2018
Featured Video: This week’s featured video is on Canterbury’s Market States and Security States.  Canterbury has identified 12 unique Market State Environments.  5 of these States are Bullish; 3 are Transitional, and 4 are Bearish. 


Market State 6- Transitional: The stock market remains in a Transitional Market State and within a normal Bull Market correction of about 10-12%.  The current Transitional Market Environment is characterized by high volatility and negative short-term supply & demand indicators. This Transitional Market Environment stems from a spike in volatility coming from an extreme low volatile environment.  In a Transitional environment, the market is subject to have an increased amount of “outlier” days (+/-1.50%).  Since the beginning of October, there have been about 13 days, up or down, that qualify as an outlier day.  In this type of Market Environment, the market has no idea where it wants to be, and it will take some time to figure it out.

Canterbury Volatility Index (CVI)- CVI 87: The Market’s CVI reading of 87 is indicative of the current Market Environment. CVI 87 is higher than that of a normal bull market, but it has not substantially increased in the past few weeks.  As pointed out in the “Market State” section, there has been a lot of noise in the market with “outlier” days.  Given the large amount of noise, volatility has remained relatively constant. Following the volatility spike in mid-October, the market increased to CVI 80 on 10/24.  Since that point, volatility has stayed in a consistent range of 80-89, often fluctuating around the CVI 85 level. Canterbury monitors CVI, and all of its other indicators, on a daily basis.  Canterbury will be on the lookout for either an increase or decrease in volatility

Market Update:
The global equity markets lost the skirmish between buyers and sellers last week. The Dow was down -4.4%; the S&P 500 -3.8%; NASDAQ -4.3%. The S&P 500 is now down -10% from its 9/21/18 peak and the NASDAQ 100 is down -14.7% from its 8/20/18 peak.  
 

Canterbury 12 Market State Environments – 5 Rational and 7 Emotional or Irrational
 
Comment:
Liquid financial markets will fluctuate based on the real time buy and sell actions of investors. Therefore, the volatility of the price changes is directly impacted by the variable levels of rationality or irrationality currently being displayed by investors.
 
The behavior of markets/investors fall within the “rational” ranges most of the time, and therefore, markets are generally stable. A rational market, as defined by Canterbury’s first 5 bullish-Market State environments, should see about 68% of the daily trading days close, either up or down, by less than about +/- 0.75%.  If the S&P 500 is in a rational market environment, it should only experience a trading day of more than +/- 1.5% about 4 or 5 days out of 100 trading days.

A normal “rational” market correction (peak to trough decline) should be limited to about -8% to -10%, with rare outlier of about -12%, from the previous highest value. This -8% to -12% “drawdown” (decline in value) is normal market behavior. These “random” fluctuations may occur at any time and for any reason.

On the other hand, “irrational” environments (Market States 6 through 12) defy predictable probabilities and can experience many days +/- 1.5% or greater. Total market declines can exceed -20%, -30%, -40% or more.

The Canterbury Market State, on the S&P 500 shifted to a Transitional environment on October 10, 2018. Including the 10th , the S&P 500 has experienced 13 trading days, out of the last 32 days, that were right at +/-1.5% or greater. A rational environment would expect 1 or 2 days, out of 32 days, to exceed +/-1.5%. In fact, of the previous 100 days prior to the shift to Transitional Market State 6 on October 10th, 0 days exceeded +/- 1.5%.

Adaptive Portfolio Strategy
Volatile market periods are similar to a military battle made up of many skirmishes. The day to day skirmishes provides an opportunity to adjust our tactics to better manage the less predictable behavior of an emotional foe.
The primary objective of adaptive portfolio management, like the Canterbury Portfolio Thermostat process, is to react and “adapt” to the changing market environment. The goal is not to win all the skirmishes, but to ultimately win the battle.
 
In adaptive portfolio management, winning the battle is accomplished by limiting risk to normal corrections. The primary goal is to limit peak to trough declines to a normal, rational market correction of about -8% to -10% with rare outliers of about -12%.
 
Bottom Line:
Don’t be concerned by the noise of the day to day volatility.  The day to day skirmishes (fluctuations) are long forgotten after the battle is won.  Instead, focus on the portfolio’s ability to adapt and limit declines to normal market corrections.  The goal is to experience the benefits of compounded returns over a lifetime of investing.
 
 
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.