Volatility can move from one extreme to another

Volatility can move from one extreme to another

Posted on June 20, 2016
Weekly Update
6/20/2016

Market State Environment (Transitional): Transitional environments are periods when both bullish and bearish market characteristics exist.
 
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.
 
The Portfolio Thermostat model portfolio’s CVI = CVI 20 (Low Risk)
The Portfolio Thermostat model’s CVI remained the same as the week before. The model was actually up most of last week while most major market indexes were down. It finished down just a fraction at the close on Friday.
 
The S&P 500’s Canterbury Volatility Index (CVI) = CVI 54 (Low and Decreasing Volatility):
Volatility typically increases when the market declines. Last week, the S&P 500’s CVI declined another 2 points, in spite of a -1.2% drop in the value of the index. Canterbury’s studies show that volatility is likely to experience  certain times of extremes, with periods of very high volatility often followed by periods of very low volatility and vice versa. The current CVI of 54 is only one point off of the volatility reading (of 53) that was registered approximately this time last year. Last year, the low volatility reading was followed by a sharp decline several weeks later.




This is neither an unprecedented nor rare phenomenon. The following chart illustrates it happening back in 2011. Many other examples exist of sharp market declines being preceded by sustained advances and extremely low CVI volatility.  



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. Examples are marked below.



Bottom Line:
Whether or not the same will be true of this current environment, it is certainly not out of the realm of probability that we could witness a decline in the market over the next few weeks.
 
Regardless, the Portfolio Thermostat is designed to manage the risk associated with such events. Because of its daily monitoring capabilities, the Thermostat model portfolio has over the past 6 months limited its max drawdown to only -2.5%, whereas the S&P 500 had a drop of -13.5%. 

 

 

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.