Weekly Update

Markets have a tendency to do what they can to surprise the masses.  We see this occur often, particularly when we try to relate the news to market events.  GameStop was an exaggerated example of this.  GameStop, a brick-and-mortar shop where you can purchase physical copies of video games, is a dinosaur company.  Video games are easily downloaded straight to gaming consoles today, and there is a possibility that the video game store may be the next Blockbuster.  I think it is safe to assume that the masses were surprised when a flood of internet investors drove the stock price up from $4 per share in August to nearly $500 per share in late January.  I think most speculators that took a position in the stock after it had already hit the news cycle were equally surprised when it did not continue to go up, and in fact dropped -89% from the peak in about a week’s time.

If we look at the broad markets, it might surprise some people as to which areas are showing strength.  If you watch the news at all, it will come as a surprise that any area in the market has strength.  One would not think that given all the events that have occurred in the last year, that stocks as a whole would be in the position that they’re in.  Even more surprisingly, one would not think that small-cap stocks are leading the markets right now and are in a stronger position today than they were two years ago, prior to the pandemic that shut down the economy.

Small cap stocks, like the Russell 2000, and Mid cap stocks are leading the broad markets, which is a good sign—you like to see a rising tide lifting the ships, as opposed to just a few select stocks.  Up to this point, the markets had been exclusively led by the technology-related stocks.  It seems as if some areas of the market are playing a game of “catchup” and there is a significant rotation in market strength/leadership occurring.

If we go back to the news cycle, one topic that has been recently discussed is Biden’s plans for energy.  One would think with some of the headlines that it would be doom and gloom for the energy sector.  There have been recent reports of layoffs; Shell energy reported they would not be increasing salaries this year and warns of layoffs in the future.  However, given the bad news, and the fact that markets are counterintuitive, energy stocks are increasing in strength.

For the majority of the last few years, the energy sector has been ranked in the bottom tier of the US sectors, on a risk adjusted basis.  Now, according to Canterbury’s risk-adjusted strength indicators, energy stocks are rising.  In fact, it is now the 5th strongest risk-adjusted sector.  The chart below shows one segment of the energy sector, Oil & Gas Exploration.  You can see from that chart that over the last 2 years, these oil and gas stocks have been in a bear market, falling well below their 200-day moving average.  Recently, in the last few months, they have broken above their 200-day moving average, showing a change in trend:

Source: AIQ

The top 5 risk adjusted sectors are: Financials, Communications, Discretionary, Technology, and Energy.

Bottom Line

Every liquid traded security is driven by the law of supply & demand.  There have been countless examples of companies that produce stable cash flows, but have stock substantially decline, as well as companies that can go 10 year without making any money, but see their stocks climb at an exponential rate.  Owning a stock, or basket of securities, is not like owning a business.  In a business, you make management decisions based on your expectations of the future. Those decisions that you make are with the goal of increasing net revenues.

Owning a security, on the other hand, is not like owning a business.  You do not make management decisions that impact the underlying company.  As an investor, the advantage to owning a stock is liquidity.  Business owners are tied to their business and are tied to that business’s profits and earnings.  Stock owners are tied to the fluctuations that come from supply and demand and the emotions of other investors.  If an investor does not use liquidity to his/her advantage, then it becomes a disadvantage, subjecting the investor to the substantial declines that can come from bear markets.

Canterbury has a process for identifying the difference between a Bull and Bear market and aims to use liquidity as an advantage—to rotate between asset classes and securities that are benefiting from low-risk characteristics.  Our system has a process for identifying asset classes that are rising in strength.  That system is not based on the fundamentals of the security but is based instead on the current supply & demand characteristics.

In other words, a sector like oil and gas can be identified as rising up the list, and our portfolio management process can select that security to hold.  On the other hand, we have mentioned that 20-year treasury bonds are exhibiting high risk characteristics.  In that case, as opposed to a traditional buy and hold method, the portfolio management process will not hold a position in 20-year treasuries, but rather hold inverse 20-year treasuries—which benefit from the higher volatility in treasury bonds.  The goal is to achieve compounded returns, by avoiding bear markets and substantial declines.