Formulating Game Plan
Today, using our new CCM Market Risk Model, we are examining six corrections that occurred in markets with similar profiles to what we have today. The median drop in those similar cases was 6.65% occurring over 38 calendar days. Nothing yet says a correction has to occur now.
Our goal today is to use the new model to determine simple boundaries to separate shallow corrections, typical corrections, and significant corrections/bear markets. This information will help us answer “should we buy this dip?” Right now, based on the model’s current level the answer is “yes”, but it remains to be seen if that will hold up.
The CCM Market Risk Model (MRM), which we will explain to clients in more detail soon, will enable us to establish some firm rules to keep allocations on track during volatile periods.
Two examples of MRM questions are below:
Is the S&P 500 above its 200-day moving average?
Is the weekly Dow chart on a MACD buy signal?
The MRM answers 117 questions, many based on “risk on / risk off” ratios (e.g. S&P 500 relative to intermediate-term Treasuries). The MRM can be updated in about 15 minutes each day by answering “yes” or “no” to questions about the current state of the markets. It operates on a scale of 0 to 100, with 100 being the risk-on end of the spectrum. It is easy to use and understand since a reading of 50 tells us 50% of the risk-on vs. risk off signals are bullish. Conditions are more favorable between 50 and 100. Conditions are less favorable between 0 and 50.
We have more work to do in terms of historical analysis, but an example of how the model will be used during a correction is shown below:
85-100: Stay fully invested
65-84: Reduce risk exposure by 10-15%
50-83: Reduce risk exposure by an additional 10-15%
40-50: Reduce risk exposure by an additional 10-25%
0-40: Low risk allocations
The incremental changes to allocations can also work in reverse order as weak markets improve.
