This week’s market commentary will discuss volatility, the overbought state of the markets, the Consumer Discretionary sector, and Gold.
Volatility
Decreasing volatility is a “bull” market characteristic. Most new market highs occur on low or decreasing volatility. Low volatility is a sign that the market is trading efficiently, and not trading on a high degree of emotion.
But volatility can get too low. Currently, our Canterbury Volatility Index (CVI) for the S&P 500 measures CVI 55. Our studies show that when volatility drops below a Canterbury Volatility Index reading of CVI 50, the markets are prone to experience an “outlier” day. An outlier day is defined as any trading day that exceeds +/-1.50%. That number of +/-1.50% is based on bell curve math.
When the market is stable or is trading “efficiently”, investors should expect to see between 10 and 20 outlier days over the course of a year. So far in 2024, there have only been two outlier days. As we approach extreme low volatility, statistically speaking, the market could be due to see an outlier day or two.
I should note that more often than not, during normal market conditions, market fluctuations typically will go back to normal following an outlier day. The outlier day relieves some “pent-up” pressure caused by squeezed down volatility. If outlier days continue to occur, in clusters, it could be a cause for concern of rising volatility. None of that has occurred yet.
Overbought Markets
When looking at the short-term, markets are not quite “overbought” or overextended (according to the technical RSI indicator). Overbought conditions occur when the markets have moved too far over a short period. However, when we look at weekly data, markets have been overbought for several weeks. The S&P 500 has registered overbought conditions for the last 11 consecutive weeks. This is the longest weekly streak since January 2018.
Quite a few individual sectors are also overbought. Communications has seen overbought conditions for 12 straight weeks (a record); Financials has been overbought for 11 weeks; Industrials has been overbought for 8 weeks; and Energy just registered its first weekly overbought condition since May ’22.
Based on what you just read, it should be apparent that overbought conditions can stay in place for a while. Eventually, however, they will come to an end. Given the our statement on volatility, could a potential outlier day relieve overbought conditions?
Consumer Discretionary
Looking at a chart for the Consumer Discretionary sector, nothing appears to be alarming on the surface. The sector appears to have an orderly pattern, but appearances can be deceptive. Sectors are cap-weighted averages of their components (larger company stocks are given more weight). When we look “under the hood” of the Consumer Discretionary sector, there are some concerns.
To keep things simple, in 2024, the Consumer Discretionary sector is up about +1% (through Friday, April 5th). Amazon is the sector’s largest component, representing 25% of the sector’s capitalization. This means that Amazon accounts for 25% of the sector’s daily performance.
Year-to-date, Amazon (which our Canterbury Portfolio Thermostat currently owns) is up 21.80% on the year (through Friday, April 5th). That stock represents a quarter of the sector, so how would the sector only be up 1%? Well, the sector’s other large components aren’t doing as well.
This year, Tesla (12% of CD sector) is down -33%; Home Depot (9% of sector) is up 3% but has fallen -9% in the last 10 days; and McDonalds (4% of sector) is down -10%.
Bottom line, Amazon appears to be what is keeping the sector afloat. The largest nine Consumer Discretionary stocks make up 67% of the sector and are down -4% on average this year. Remove Amazon from that equation, and those 8 stocks are down -7% on average this year.
Chart of the Week- Gold
One month ago, in our March 4th commentary titled “A Rising Tide and a Look at Gold,” we featured Gold as our chart of the week. We showed a chart of the Gold ETF, GLDM. In that commentary, we noted that the Gold ETF had broken out of a large sideways trading range to a new all-time high. It had done so on declining volatility. Our Canterbury Portfolio Thermostat portfolio strategy took a position in Gold that week. Here is an updated chart on GLDM:
Source: Chart created by Canterbury Investment Management using Optuma Technical Analysis Software
Since breaking out to a new high, Gold has taken off like a rocket, rising +12% since March 1st. This is a security that had moved sideways since July 2020.
It is interesting that Gold is typically viewed as a hedge against inflation. Inflation seemed to be at its worst when rates were rising in 2022, yet that was also when Gold was at its worst, experiencing a -20% peak-to-trough decline that year. It goes to show you that asset classes don’t always correlate with conventional wisdom.
Today, the rise in Gold could now be correlated to the inflation and interest rate discussions. In late 2023, there were talks of rate cuts in 2024. Now, that sentiment has started to shift as investors begin to question if those cuts will come this year. While Gold has taken off, bonds (which are interest rate sensitive) are in a downtrend. Whatever the reason for Gold’s rise, at the end of the day, Demand is exceeding Supply. As the saying goes, “the trend is your friend.”