After a federal holiday last Monday, the S&P 500 rallied for the week, and included two outlier days of +2.45% and +3.06%. As a reminder, an outlier day is any single trading day beyond +/-1.50%. As we wrote last week, “Through the first 6 months of 2022, you would expect see about 6 outlier days beyond +/-1.50% [based on bell curve math during a normal, efficient market environment].” The number of outliers in 2022 is now up to 43 outlier days. Again, in a normal market environment, you would expect to have 6 days. The S&P 500 has had seven times as what was expected. This is reflective of a highly volatile bear market environment.
Bear markets, like we are seeing today, will feature large rallies. Last week’s outliers were two very large “up” days, but that doesn’t mean we are seeing a shift in market environments. In fact, volatility is going up, not down. The Canterbury Volatility Index (CVI) is now at a 2-year high. High volatility is the primary characteristic of a bear market. In order to for the bear market to change to a bullish or transitional Market State, two things would need to occur.
To change from a bear to a bull/transitional market environment:
- Volatility needs to decline by at least 20-30%. Right now, volatility is at CVI 146. Generally speaking, a volatility less than CVI 75 is considered low and stable.
- We need to see a series of higher highs and higher lows. Bull markets are characterized by a steady and slow, upward climb where the markets put in a high, and then pullback and put in a low, followed by a rally to a higher high and pullback to a higher low. Right now, we have only seen lower highs and lower lows. It will take time for this process to play out.
Some Charts to Watch
Across the board, every global equity ETF in our universe (which is about 150 ETFs) is in a Bearish Market States. Keep in mind that there are several ETFs in our “alternatives to global equities” category that are in Bullish Market States, most of which are inverse ETFs. That being said, we are paying special attention to risk-adjusted relative strength in few different areas, some of which are highlighted below.
Energy
The energy sector has been the best performing S&P 500 sector in 2022. Recently, the sector has experienced a large pullback. Right now, it appears to be sitting on support. The ideal scenario is for the group of energy stocks to bounce upward off this support level.
Source: Canterbury Investment Management. Chart created using Optuma Technical Analysis Software
Pharmaceuticals
One of the biggest movers in Volatility-Adjusted-Relative-Strength (VWRS) rankings has been the pharmaceuticals industry. Interestingly, pharmaceuticals last put in a high back in February 2021, and had since fallen more than -30% from that high. Recently, however, it climbed up in ranking on our daily reports after a rally experienced over the last two weeks. Looking at the chart below, you can see it has been trading in a “channel” which features falling support and resistance lines that the security tends to fluctuate between. The industry is now at the upper end of its range. Will it follow the probable trend and decline back to support, or will its rally continue, break above resistance and begin a new trend?
Note that the support and resistance lines being drawn are fairly arbitrary and should be drawn with a “thick” pen. There have been a few times where the ETF has broken above resistance for a short period before declining below it. Ideally, a break above resistance would be followed by a pullback to the resistance line before bouncing off of it and confirming the line as new support.
Source: Canterbury Investment Management. Chart created using Optuma Technical Analysis Software
Technology Stocks
Technology-related stocks are by far the largest component of the broad, US markets. In other words, if technology stocks struggle, they will tend to pull market indexes down with them. That is what has occurred in 2022. On the flip side, any rally in technology-related stocks should pull the markets higher. Recently, we have seen the relative strength of the Nasdaq (a technology-based index) versus the S&P 500 tick higher. This rotation has not occurred long enough to indicate a confirmed shift in momentum towards tech stocks, but we are keeping a close eye on it.
Source: Canterbury Investment Management. Chart created using Optuma Technical Analysis Software
Bottom Line
Even with the large up days and rally seen last week, the markets are still about 85% oversold. This would lead to the expectation of a further “bear market rally” in the days ahead. That said, we would continue to expect lower prices in the future.
The objective is not to call the direction of the market and the length of time it will take the indexes to get back to a normal market environment. Our objective is to efficiently diversify the combination of securities in the portfolio in order to maintain low and consistent volatility, regardless of the overall market environment.
To accomplish the talk of maintaining stability, the portfolio will require a combination of both long and inverse ETFs. By maintaining a more stable portfolio with low volatility, the portfolio can benefit from the market’s volatility, rather than being punished by it, by limiting portfolio declines and coming off a larger dollar base value with each subsequent rally.