Watch for the 800 Pound Gorilla in the Room

Watch for the 800 Pound Gorilla in the Room

Posted on November 10, 2014

Canterbury Portfolio Thermostat-Weekly Update- 11/10/2014

Market State 1 (9 Trading Days) Long-term (Bullish) Short-term (Bullish/Transitional): Market State 1 is the most Bullish of the Portfolio Thermostat’s 12 Market States. The first phase of Market State 1 can be a little sluggish coming out of the gate. In fact it is normal to see a market pullback during the first two or three weeks of Market State 1. This is because stocks are typically overextended as a result of the previous short term advance needed to transition from Market State 2 to Market State 1.Please read last week’s Weekly Update to learn more about characteristics of the first phase of Market State 1. 

Canterbury Volatility Index is at CVI 66 (Bullish): The CVI (volatility) has now decreased two weeks in a row, following 6 weeks of increasing volatility. As a point of reference, a volatility reading below CVI 75 is considered to be in the “safe zone.” 

Overbought/Oversold "Oscillator” is currently 97% overbought (Short-term Bearish). A reading over 95% is considered to be an extreme market environment. The US equity markets need a short term pullback or a sideways period of consolidation to work off the overbought condition that resulted from a sharp rally in most major equity markets.

Market Comment:

Just as we were getting used to the rollercoaster ride, the equity markets finally had something resembling a “normal” week. The S&P 500 finished the week up 0.7% and the NASDAQ was down -0.1%. Prior to last week, the NASDAQ had been outperforming the S&P 500 going back to the October 15th low.

Top market technician, David Vomund, at Vomund Investment Management, had some interesting observations: “The S&P 500 recorded a new high in early July. At that time, 32% of the S&P 1500 stocks were within 2% of their yearly highs. The S&P 500 put in an even higher high on September 19th but only 16% of the stocks were near their highs. In other words, the market’s internals were deteriorating.” Combine the deteriorating market breadth with complacent investors who were experiencing the lowest volatility (as measured by the CVI) seen in over 7 years and the stage was set for an emotional market “whipsaw.” 

The S&P 500 began its 7 plus percent correction (normal correction during Bull markets) from its peak on August 19th.  The final market bottom “capitulation” (throwing in the towel) occurred on October 15th. On that day, the Dow was down as much as 460 points in the afternoon and then rallied back to finish down 173 points on the day.  The S&P 500 Exchange Traded Fund recorded its highest daily volume since 2011. To the surprise of most, the market then advanced back to new highs in just 11 trading days.

 

Overly emotional investors, who were whipsawed out of the market at the bottom, have been a primary source of new buying as they repurchase the same stocks they sold near the low, but now at much higher prices. Those who capitulated, and did not buy back, missed a 7.7% rally in just 12 trading days to close out the month of October. This is a prime example of why investors need an established rules based strategy and a strong investment discipline to avoid mistakes during difficult environments. 

Today the market participation statistics are showing an improving environment.  Now 35% of the S&P 1500 stocks are near their highs compared to 16% at the September market high. David Vomund added another important observation to help explain the improving longer term picture for the U.S. equity markets. In fact, the Large Cap equity markets look even better than they did the last time they were at new highs. David answers the question; Why the quick recovery to highs? He points to what he called the “800-pound gorilla -- the needs to put money to work. I've (David) made my bullish case in part because hedge funds, pensions, endowments and both professional and individual investors need to put money to work. Where will money be treated best? In bonds? Not at such low rates. In commodities? Not practical for most investors. In gold or silver? The worst investments over many years and they pay nothing. Treasury bills, money-market funds, CDs? They pay almost nothing. So what's left? Stocks that pay dividends and increase their earnings.”

Highlights on the Portfolio Thermostat’s Sector ETF holdings:

The Portfolio Thermostat’s Universe of over 130 Exchange Traded Funds are divided into two Groups. About 80 ETF make up the “Global Equities” Group which includes: Style/indexes, Geographic Regions, Countries, Sectors and Industries. The second Group is comprised of “Alternatives to the Global Equities” and would include: Bonds, various Commodities, Currencies, Real-Estate and Inverse ETFs.

Currently, the higher yielding and somewhat defensive equity ETFs are leading our “Volatility Weighted Strength” ranking list. The S&P 500 is grouped into 9 major Sectors. Currently 5 of the 9 Sectors are ranked in the top 11 strongest ETFs in the Global Equities Group. The following is a list of the top 5 Sectors and their overall ranking among over 80 ETFs in the Global Equities Group:

•    Utilities Sector (XLU) - Ranked/Position 1 (strongest volatility weighted)
•    Consumer Staples Sector (XLP) - Ranked/Position 3
•    Health Care Sector (XLV) - Ranked/Position 6
•    Financials Sector (XLF) - Ranked/Position 7
•    Technology Sector XLK) - Ranked/Position 8

*The Portfolio Thermostat currently owns all 5 of the top 5 Ranked S&P 500 Sector ETFs. The typical number of P.T. holdings, during a Bull market is between 12 and 14 ETFs.

Bottom Line:

The short term market environment is over extended and is likely to pull-back enough to move our Overbought/Oversold "Oscillator,” currently 97% overbought (Short-term Bearish), to somewhere in the middle/neutral range.

Markets are counterintuitive. Investors tend to feel the most optimistic at peaks and pessimistic at bottoms. The Portfolio Thermostat is a comprehensive portfolio management strategy designed to maintain consistent and low volatility through all market environments: Bull or Bear. The investor’s primary role is to maintain a strong and consistent investment discipline as the process works its way through the cycles.

Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom Hardin, Chartered Market Technician (CMT), makes all the final decisions on all investment and portfolio management decisions for Canterbury Investment Management. Tom has more than 30 years experience in the investment management industry and has broad breadth of knowledge. He is known as an innovator, educator and been revolutionary in the advancements in 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.