Cyclical Strength Index
The CSI Ratio is most valuable as a predictor of market confidence and short-term performance. As the real-time and lagging CSI Ratios rise and fall, their relationship to each other – as well as their positive and negative distance from 0 - works to define which of four 'quadrants' the index is currently in.
The chart below illustrates this relationship as well as the index's real-time and historic 'quadrant' dating back to January 1, 2015. (Leverage 'zoom' interface to look at any period.) The chart also presents an overlay of the S&P 500 value dating back over the same period – useful in assessing the CSI Ratio's accuracy as a market predictor.
Quadrant Definitions: 1) Expansion – Green, 2) Consolidation – Yellow, 3) Contraction – Red, 4) Reflation - Blue
"Based on rolling performance measurements of select cyclical
versus defensive sectors in S&P 500, the CSI assesses the
perceived market risk and predicts the market's short-term
prospective movements at a given point, as a discernible ratio."
- William Gorfein, Index Developer
A Proprietary Ratio
The Cyclical Strength Index is a proprietary ratio of the performance of cyclical sectors/companies versus defensive sectors/companies, at a moment in time.
Perform well when the economy does well.
Discretionary goods and high profile brands like Starbucks and Nike.
Predicting Perceived Market Risk
As a result, the CSI will always have an inverse relationship to "perceived market risk".
Predicting Market Position
The CSI ratio defines the market as being in one of the four "quadrants" at any given moment.
Each quadrant can be defined by its own distinctive characteristics and behaviors.
Historical Time Per Quadrant
Considering the steady growth in the S&P 500 index since early 2015, it is no surpirse that the market has spent the vast majority of its time in the more normative EXPANSION (1) and CONSOLIDATION (2) quadrants, and far less time in the more reactionary CONTRACTION (3) and REFLATION (4) quadrants.
The CSI Ratio, and its corresponding
quadrants, are excellent predictors
for identifying periods of general
market appreciation and relative
Avoiding Quadrant 3 Creates 54.2% Better Returns
Since January 1, 2015 the S&P 500 would have returned 89.0% for investors who kept their money in the market at all times.
If those same investors had simply pulled their money out of the market and kept it on the sidelines during all times when CSI indicated the market was in Q3, their returns, over the same period, would have been 143.2%.
Best Daily Returns in Quadrant 4
While the S&P 500 has spent the least amount of days (15.8%) in quadrant 4 since January 1, 2015, the average daily return on these days has been 520.0% better than the overall daily average.
Forecasting Actual Volatility
It makes sense that daily volatility is highest during periods of CONTRACTION and REFLATION (Quadrants 3 and 4, respectively), as these represent periods of adjustment.
While investing styles vary, it is always valuable to understand when periods of high volatility are expected.
Maximizing Risk Adjusted Returns
Analyzing the historical Sharpe Ratio of each distinct CSI quadrant shows that an actively managed portfolio can, indeed, outperform a passively managed S&P500 index fund on a risk adjusted basis.
- Only investing in Quadrant 1 and 4 beats the market by ~50% on a risk adjusted basis
- Moving to cash during Quadrant 3 eliminates periods in the market of negative Sharpe Ratios and significant market turbulence.
Predicting Implied Volatility
Looking at historical implied volatility levels in relation to the CSI Ratio since January 1, 2015, it is clear that the index can be used by investors to isolate the most advantageous times to hedge risk of their investments.
Continue to Deeper Dives