Who says Markets go Down Faster Than UP

Who says Markets go Down Faster Than UP

Posted on November 03, 2014
Canterbury Portfolio Thermostat-Weekly Update- 11/03/2014

Market State 1 (3 Trading Days) Long-term (Bullish) Short-term (Transitional): Market State 1 is the most Bullish of the Portfolio Thermostat’s 12 Market States. To better understand Market State 1 we must first clearly understand what typically occurs when there is a change in the environment causing a shift out of Market State 2 and into Market State 1.

An upgrade from Market State 2 to Market State 1 will be preceded by an advance in the S&P 500 index. The required upward move will “burn up” a portion of short term buying power (demand). As a result, the first stage of Market State 1 will typically begin with a slight pull-back or a sideways/sluggish period as the market digests the recent gains. The upgrade in Market State is definitely NOT normal.

 

In the current case, the S&P 500 advanced 6.4%, from the closing low, in only 9 trading days. If we measured the advance from the intraday low on Wednesday afternoon October 15th at 1821, through the day of the upgrade to MS 1, the S&P 500 advanced 8.84% during the 9 days. Such a parabolic rally is more typical during a volatile Bear market that would tend to be a “knee jerk” reaction to a sharp double digit percentage decline.

Canterbury Volatility Index is at CVI 70 (Bullish): The CVI (volatility) actually decreased by 1 point last week. A 1 point decrease in the CVI is by no means significant, but it is the first time in over 6 weeks, that the Portfolio Thermostat’s volatility index did not increase. That said the CVI has increased 78% from the lowest reading (Transitional characteristic).  A volatility reading below CVI 75 is considered to be in the “safe zone.” 

The peak to trough declines (drawdowns) are typically about 4% to 8% during Bull- Market States 1 through 5. Bear and Transitional Market State declines can be in the 8% to 12% ranges. The traditional definition of a Bull market correction is a 10% decline from the peak. The S&P 500’s total correction was -7.24%* from the peak on 9/19 to the low on 10/15. Normal Market noise.  Source: Orion Software

Overbought/Oversold "Oscillator” is currently 100% overbought (Short term Bearish). A reading over 95% is considered to be an extreme reading. Many of those who capitulated during the middle of the month rebought over the last few days of October. The global equity markets are likely to see a NORMAL short term correction very soon.

Market Comment:

The recent S&P 500’s -7.4% decline was punctuated by a surprising wild capitulation on Wednesday 10/15. Even more surprising, was the rebound to a new high that occurred even faster than the previous decline. So much for the old saying that “the market declines are much faster than the advances.” 

Here is a comment from the our weekly update, two trading days, following the capitulation on Wednesday 10/15: “Wild days like Wednesday, that begin with a big drop then finish in the upper half of the trading range can be a sign of a capitulation. A capitulation means that the emotionally weak holders tend to throw in the towel at the bottom, while the more experienced investors will begin buying near the close after the selling is finally exhausted.” 

Last week’s (10/27) comment deserves to be repeated this week: “It is not typical for the market to experience a volatile correction and then go right back to hitting new highs like nothing had happened. The V pattern (sharp decline and sharp advance) is VERY unlikely. The higher probability is a pattern that would resemble a W.”

S&P 500 INDEX – 10/31/2014: V SHAPED PATTERN 

The chart below is a text book example of the consolidation/process. For example, the “94” to “95” market correction resembles more of a W pattern, prior to a resumption of a healthy Bull market.

S&P 500: LATE 1994 through EARLY 1995

The “spikes” on the left side of the bars represent the close for the day. Please note the “capitulation” days on the “lows.” For example, the long bar represents the high and low for the day. The “LOWS” are long bars that close near the high. The 3rd low above capitulated the day after the arrow marking the LOW. Investors tend to throw in the towel at the bottom. 

The important point to grasp here is that markets are counter intuitive. Your gut feeling, regarding market direction, will most likely be wrong.

Observation – Difficult Market Environments

Whipsaw market environments, such as the one we are currently experiencing, will occur regularly and when investors least expect. The good news is that whipsaws have identifiable characteristics and definable markers which allow them to be effectively managed. 

Investing can be a challenging and a draining experience when the investor allows emotions to take over. Even the best portfolio management process will fail if the investor lacks the patience and confidence to maintain a strong investment discipline every day and maintain it over the long run.

Long term investing requires patience to maintain a strong “investment discipline” and the fortitude to avoid subjective decisions based on hearsay or short term emotional “gut feelings.” Patience and confidence and discipline can come from the use of rules based processes to make important objective decisions.

Any viable portfolio management strategy must be based on quantifiable rules. These rules should measure various aspects of how supply and demand is currently affecting liquid securities and the portfolio as a whole. A comprehensive portfolio management model must produce specific actions based on defined rules and make measurable claims. The statistical valid predictive value is the result of extensive testing through a variety of market environments, ranging from normal to volatile and sometimes irrational markets. In other words, Effective portfolio management is an objective science, not a subjective art. Subjectivity has no place in portfolio management simply because there is simply no way to test the potential predictive value added.  

BOTTOM LINE:

Subjective investment decisions based emotions, gut feelings, short term worry or over confidence is without question one of the biggest risk investors face today. It is human nature to be pessimistic at market bottoms and optimistic at market peaks. An investor’s decisions to circumvent a defined portfolio management process is typically the result of a lack n a lack of patience due to a loss in confidence in the portfolio management process. 

Portfolio Thermostat’s Goal:

The Portfolio Thermostat’s goal is to maintain consistent portfolio volatility through all market environments. The purpose of the Portfolio Thermostat is to help maintain acceptable portfolio fluctuations and to avoid "substantial declines.” Substantial declines destroy the likelihood of generating long term compounded returns, which is the primary objective of all long term investors. 

The Portfolio Thermostat model continues to meet its primary objectives: 

1)   It limited declines to normal fluctuations/market noise.   2)    It maintained the investor’s initial investment as well as past gains within the range of normal fluctuations/market noise.   3)    It participated in meaningful major market advances*

 

*The Canterbury Portfolio Thermostat was ranked 9 in total return of 573 Separate Managed Account (SMA) strategies for 2013. 

Source: Pension and Investment Magazine data provided by Morningstar. 

The Portfolio Thermostat’s goal is NOT to beat the short term performance of any fixed benchmark comprised of a fixed allocation of market indexes.

 
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.