Right now, the average investor’s appetite for risk appears to be low. According to Canterbury’s risk-adjusted rankings, the top two sectors are Utilities and Energy (which combine for 7.7% of the S&P 500’s market cap), while the bottom two sectors (out of 11) are Information Technology and Communications (which combine for 34% of the S&P 500’s market cap). In other words, sector leadership is favoring the smaller, “defensive” sectors.
Speaking of defense, bonds have been anything but defensive. The twenty-year treasury bond ETF (Ticker: TLT) reached a new low for the year and its lowest level since early 2014. That puts that ETF down -27% year-to-date. For the traditional conservative investor, bonds are supposed to be the risk-off asset. When the stock market goes down, the hit to their portfolio should theoretically be limited or offset by their bond holdings. That theory has not worked in 2022.
Given the market’s decline last week, it should come as no surprise that the market is short-term oversold. One point we should establish is that overbought/oversold indicators do not tell us when the market will have a turning point and fluctuate up or down, nor do they tell us the extent of a kickback or drawdown. An oversold market can always become more oversold. During volatile markets, oversold or overbought conditions can hit extremes more often than they would in a normal market environment. These indicators are unconfirmed and very short-term, meaning it is best to act on them after there are some confirmations that the security or index wants to go up.
Here are two other points for the short-term. Currently, the Nasdaq’s weekly relative strength is flat. A positive indication for the market would be that the Nasdaq is leading the market, or S&P 500. That would show that investors have an increased appetite for risk. That is not the case right now, but it is better that the relative strength of the Nasdaq is flat as opposed to down. The other point is that there is a slight divergence in the Advance-Decline line, which measures the number of stocks rising versus falling. While the S&P 500 has put in a relative low for the last few weeks, the stocks-only AD Line has not. This is only a small positive for the market, as the Advance-Decline Line works as a better indicator for identifying major tops and bottoms, and not mid-cycle moves over the short-run.
The Long Term & Bottom Line
This is a bear market and Canterbury’s Market State Indicators have all turned negative. Those indicators are Long-term trend, Volatility and Short-term supply & demand. Bear markets often fluctuate in both directions, having large declines followed by large, short-term rallies. The markets have seen that several times this year. So, the question then becomes “for the long-term, what is the plan?”
Here is the positive: every bear market is eventually followed by a new bull market. That does not mean that your investment plan should be to just buy and hold for long-run, hoping to come out better on the other side. Bear markets can be devasting to investors and cost them years of compounding just trying to get back to breakeven. This is amplified by a falling bond market, where bonds are doing very little to offset portfolio risks.
The key to benefitting from a bear market, rather than being punished by it, is to mitigate portfolio fluctuations. We know that in the short-term, markets are going to fluctuate in both directions. Long-term success requires a series of short-term decisions. Adaptive portfolio management is all about managing the short-term fluctuations and positioning the portfolio to benefit in the long-term. The goal is to adapt the portfolio to manage each of the market’s up and down fluctuations. By limiting risk in the bear market, an adaptive portfolio can be better suited to compound in a bull market.
Canterbury’s adaptive portfolio, the Canterbury Portfolio Thermostat has been successful at adapting in this volatile market environment, by limiting declines to normal fluctuations and participating in the various short-term rallies the market has gone through. The portfolio maintains a high benefit of diversification, where the securities being held have lower correlation to each other. This has limited the number of “outlier” days (trading days beyond +/-1.50%) to just 7 trading days (which is expected). For reference, the S&P 500 has experienced 58 outlier trading days.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.