Short-Term Markets and the Long-Term Plan

Right now, the average investor’s risk appetite appears to be low. Based on the Canterbury risk-adjusted rankings, the top two sectors are Utilities and Energy (combining for 7.7% of the S&P 500 market capitalization), while the bottom two sectors (out of 11) are Technology Information and Communications (combining for 34% of the S&P 500 market capitalization). In other words, the leadership of the sector is favoring the smaller and “defensive” sectors.

Speaking of defense, the bonuses have been anything but defensive. The Twenty-Year Treasury Bond ETF (Ticker: TLT) hit a new low for the year and its lowest level since early 2014. That puts that ETF down -27% YTD. For the traditional conservative investor, bonds are supposed to be the risky asset. When the stock market falls, the impact on his portfolio should theoretically be limited or offset by his bond holdings. That theory hasn’t worked in 2022.

The short term

Given the market crash last week, it should come as no surprise that the market is oversold in the short term. One point to make is that overbought/oversold indicators do not tell us when the market will have a turning point and fluctuate up or down, and they also do not tell us the extent of a pullback or drawdown. An oversold market can always become more oversold. During volatile markets, oversold or overbought conditions may reach extremes more often than in a normal market environment. These indicators are unconfirmed and very short-term, meaning they are best acted on after there are some confirmations that the stock or index wants to go up.

Here are two other points for the short term. Currently, the weekly relative strength of the Nasdaq is flat. A positive indication for the market would be that the Nasdaq is leading the market or the S&P 500. That would show that investors have a higher appetite for risk. That is not the case at the moment, but the relative strength of the Nasdaq is better off flat than bearish. The other point is that there is a slight divergence in the Advance-Decline line, which measures the number of stocks going up versus going down. While the S&P 500 has been relatively low for the past few weeks, the stock-only AD Line has not. This is only a small positive for the market as the Advance-Decline Line works as a better indicator to identify major highs and lows and not short-term mid-cycle moves.

The long term and the final result

This is a bear market, and the Canterbury market health indicators have turned negative. Those indicators are long-term trend, volatility, and short-term supply and demand. Bear markets often swing in both directions, with big drops followed by big short-term rallies. The markets have seen it several times this year. So the question becomes, “Long term, what’s the plan?”

Here’s the positive: Every bear market is eventually followed by a new bull market. That doesn’t mean your investment plan should simply be to buy and hold for the long term, hoping to come out better on the other side. Bear markets can be devastating to investors, costing them years of capitalization just trying to break even. This is amplified by a falling bond market, where bonds are doing little to offset portfolio risks.

The key to benefiting from a bear market, rather than being punished for it, is to mitigate portfolio fluctuations. We know that, in the short term, the markets are going to move in both directions. Long-term success requires a series of short-term decisions. Adaptive portfolio management is all about managing short-term fluctuations and positioning the portfolio for long-term benefit. The objective is to adapt the portfolio to manage each of the upward and downward fluctuations of the market. By limiting risk in a bear market, an adaptive portfolio can better match the compound in a bull market.

Canterbury’s adaptive portfolio, the Canterbury Portfolio Thermostat, has successfully adapted to this volatile market environment by limiting declines to normal fluctuations and participating in the various short-term rallies the market has experienced. The portfolio maintains a high diversification benefit, where the securities held have a lower correlation with each other. This has limited the number of “outlier” days (trading days beyond +/-1.50%) to just 7 trading days (what is expected). For reference, the S&P 500 has experienced 58 atypical trading days.

As always, if you have any questions, please feel free to call our office or send an email.

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