Right now, the average investor’s appetite for risk seems low. According to Canterbury’s risk-adjusted rankings, the top two sectors are utilities and energy (combined for 7.7% of the S&P 500 market cap), while the bottom two sectors (out of 11) are information technology and communications (combined for 34% of the S&P market cap). 500). In other words, industry leadership favors the smaller, “defensive” sectors.
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Speaking of defense, bonds have been anything but defensive. The 20-year Treasury bond ETF (ticker: TLT) hit a new yearly low and its lowest since early 2014, taking the ETF down -27% year-to-date. For the traditional conservative investor, bonds are considered a low-risk investment. In theory, if the stock market falls, the damage to your portfolio should be limited or offset by your bond holdings. That theory didn’t work in 2022.
The short term
Given the market’s decline over the past week, it should come as no surprise that the market is oversold in the near term. One point to note is that the overbought/oversold indicators tell us nothing if The market will have an inflection point and will swing up or down, nor will they tell us the magnitude of a kickback or drawdown. An oversold market can always become more oversold. In volatile markets, oversold or overbought conditions can reach extremes more frequently than in a normal market environment. These indicators are unconfirmed and very short-term, meaning it’s best to act on them after there’s some confirmation that the security or index is looking to rise.
Here are two more short-term points. Currently, the weekly relative strength of the Nasdaq is flat. A positive indication for the market would be the Nasdaq leading the market or the S&P 500. That would show that investor risk appetite has increased. That’s not the case right now, but it’s better than the Nasdaq’s relative strength being flat versus down. The other point is that there is a slight divergence in the advance-decline line, which measures the number of stocks going up and down. While the S&P 500 has hit relative lows over the past few weeks, the equity-only AD Line has not. This is only a small advantage for the market as the advance-decline line serves as a better indicator for identifying important highs and lows rather than short-term mid-cycle moves.
The long-term and bottom line
This is a bear market and Canterbury’s market health indicators have all turned negative. These indicators are long-term trend, volatility, and short-term supply and demand. Bear markets often swing both ways, with large falls followed by large, short-term rallies. The markets have seen this several times this year. So the question is: “What is the long-term plan?”
Here’s the positive: Every bear market is eventually followed by a new bull market. That doesn’t mean your investment plan should be to buy and hold for the long term in hopes of doing better on the other side. Bear markets can be devastating for investors, costing them years of compounding just to try to break even again. This is compounded by a falling bond market, where bonds do very little to offset portfolio risk.
The key to benefiting from a bear market, rather than being penalized by it, is to moderate portfolio volatility. We know that markets will swing both ways in the short term. Long-term success requires a series of short-term decisions. Adaptive portfolio management is about managing short-term fluctuations and positioning the portfolio to benefit from them over the long term. The aim is to adjust the portfolio so that it can handle all ups and downs in the market. By limiting risk in a bear market, an adaptive portfolio may be better suited to compensating 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 that the market has experienced. The portfolio maintains a high diversification benefit as the securities held are less correlated to each other. This has limited the number of “outlier” days (trading days above +/-1.50%) to just 7 trading days (which is expected). For reference, the S&P 500 has seen 58 outlier trading days.
As always, if you have any questions, do not hesitate to call or email our office.
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