Volatility can move from one extreme to another Part II // June 27, 2016

Volatility can move from one extreme to another Part II // June 27, 2016

Posted on June 27, 2016
Weekly Update
6/27/2016
 
Market State Environment (Transitional/Bearish): Transitional environments are periods when both bullish and bearish market characteristics exist.
 
The Market’s (S&P 500’s) Canterbury Volatility Index is at CVI 73. Volatility jumped an incredible 19 points on Friday triggering a volatility alert.
 
During a “Bullish” environment, the risk of a decline is typically in the -8% to -10% range (from the highest peak value), with rare outliers of -12%. During “Transitional” and “Bearish” Market environments, unconstrained risk of declines from the highest peak value can exceed -20%, -30% or more.





Canterbury Portfolio Thermostat State 1 (Bullish): The Portfolio State represents a low-risk portfolio based on the current market environment.
 
Market Comment:
The Portfolio Thermostat’s Canterbury Volatility Index declined 1 point to CVI 19 (Low Risk).
Even more significantly, the Portfolio Thermostat model was up approximately 0.14%, on Friday, while the S&P 500 dropped -3.6% and most global equity markets fared far worse.
 
Weekly Update 6/20/2016
“A Transitional market environment will eventually shift to either a confirmed Bullish or confirmed Bearish environment.  Some of the highest risk periods occur during a Transitional market shift from a Bullish to a Transitional and eventually a Bearish environment. The reason for the higher risk is that a transition from a Bull will most likely begin near the market peak and thus has farther to fall.”

With the market undergoing shifting behavior over the last few months, this would be a good opportunity to evaluate the Portfolio Thermostat’s observations regarding the state of the markets and its ability to adjust portfolio holdings to maintain stability through an unstable market environment.
 
 Weekly Update (last Monday) 6/20/2016
Volatility typically increases when the market declines. The CVI declined another 2 points, in spite of a -1.2% drop in the value of the index.
 
“The current CVI of 54 is only one point off of the volatility reading (of 53) that was registered approximately this time last year.” The S&P 500’s volatility is suboptimal at the CVI 55 or lower range. Our studies show that a pop in price, either up or down (usually down), tends to occur following a period of lower than normal volatility.” (Four trading days later, the Dow dropped 610 points in one day.)
 
Note the similarity to a Weekly Update from last year.
 
Weekly Update 8/10/2015
“The market’s volatility actually declined 3 points last week even though the S&P 500 was down  (-1.20%). It is more common to see volatility go higher when the market declines.” (Seven trading days later, one of the largest 3 day market declines in history occurred)
 
“No human or sophisticated set of algorithms can predict the future. That being said, we do have statistical evidence that shows we can identify the existing market environment and that we can determine a market’s, or a portfolio’s, likelihood of exceeding the normal market noise (a correction up to 8% to 12%).

"The current market has many of the characteristics of market environments that have eventually suffered substantial losses. We call this market environment “Transitional.” Given enough time, the sideways trading range could heal the technical damage that has been inflicted over the last year. On the other hand, “Transitional” market environments can also represent very high risk of substantial declines. The key point is that Portfolio Thermostat model is currently diversified to produce a low risk and efficient portfolio to match the current environment."

Weekly Update 6/20/2016
“The bottom line, however, is that the long-term upward trend of the S&P 500 is broken and has been broken for several months. Almost every other major equity market index looks worse than the S&P 500.”

 
Observation:
Canterbury’s studies have discovered many anomalies in market behavior that have shown statistically relevant, predictive value that defy luck or randomness. These anomalies may not mean a lot by themselves. However, when they occur in a certain order and within consistently similar Market State environments, “low-probability, high impact” market moves can become more predictable.
 
Successful portfolio and risk management requires the ability to separate a market or security that is experiencing low-risk, bullish characteristics from those that have high-risk, bearish or transitional behavior. It has been said by many that this is impossible. However, few would doubt that an expert financial analyst could separate a healthy profitable company from one headed for bankruptcy.
 
So why would it be considered impossible to tell the difference between a market environment with low risk and high, upside potential and one that is likely to lose 20%, 40%, or even 80% of its value? It isn’t impossible. This is why Canterbury has invested the time and resources to develop the Portfolio Thermostat.


Bottom Line:
The key to long term investment management success is to limit portfolio declines to normal bull market pullbacks and corrections – regardless of the overall market environment. The upside will take care of itself as long as the portfolio only holds ETFs with the bullish characteristics as defined by the Portfolio Thermostat’s Security States.

Markets spend more time in sideways trading ranges than they do trending upward. Until last Friday, the market environment can be a test of investor’s patience. The large moves typically occur when most investors least expect which is reflective of the counter intuitive nature of supply and demand.



 
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.