Market Conditions Model Lowers Risks, Improves Returns

We may be forgiven for chuckling at the Grand Old Duke of York’s obvious exercise in futility, when he marched his men to the top of the hill and marched them down again. However, the perils that made His Grace relinquish that elevated perch are similar to those faced by all investors. Many have seen their portfolios climb to satisfying levels only to witness them fall precipitously thereafter.

All portfolios face opportunity for gains along with the risk of loss or drawdowns. Tactical Asset Allocation Strategies, LLC developed its Market Conditions Model and Global Tactical Asset Allocation Strategies to assist self directed investors in capitalizing on the opportunities while lowering risk of loss.

Losses are painful, both financially and psychologically and while small losses may be inevitable, large ones can destroy portfolios, and lives. If a portfolio suffers a 20% loss, it must gain 25% to regain its original value. As losses go up, it becomes harder to recover. The 55% loss in the S&P 500 during the last Bear Market required a recovery of more than 100% over a period of 58 months.

Such dismal potential scenarios have prompted another grand figure, Warren Buffett, to formulate two investing rules: Rule 1. Don’t lose money; Rule 2. Don’t forget Rule 1. The TAAS Market Risk Model is a way of observing those rules, as far as is possible, in a perilous world.

Market Risk Model

The original Market Risk Model was developed nearly 3 years ago to identify Favorable market risk conditions which exist during roughly 50% of a full market cycle. Favorable market risk conditions occur when a trend is strong and rising.

Identifying these low risk/high reward conditions allows use of more aggressive tactical asset allocations without incurring excessive risk. The Global Satellite Strategy, designed for use under Favorable market risk conditions, shows returns which are nearly double that of the Global Core “All Weather” strategy.

The Bull Market which began in 2009 is now getting long in the tooth and valuations have reached historically high levels associated with market tops. Why not capitalize on future opportunities by identifying Hostile market conditions and developing a Global Satellite Strategy to deliver improved returns when the markets are at risk of large declines?

Improved Market Conditions Signals

The newly upgraded Market Conditions Model stuck with the same simple concepts underlying the construction of the first Market Risk Model: price momentum, credit risk, and market valuation. Detailed study of the the interaction of these elements revealed nuances which could be readily captured to provide more information and stronger signals. The resulting Market Conditions Model signals three risk conditions: Favorable, Balanced, and Hostile during a full market cycle:

• Favorable: strong market with little risk of major decline, suitable for a bullish Satellite Strategy (primarily equities)
• Balanced: risks of decline and opportunity for advance is roughly equal, suitable for Core Strategy (mix of equities and fixed income)
• Hostile: high risk of extended market decline and large drawdowns, suitable for a bearish Satellite Strategy (primarily fixed income, no short sales)

This illustration shows how the TAAS Market Conditions Model categorizes risk. The black line shows the trajectory of the SPDR S&P 500 ETF (“the market”) from early 2000 through June 2017. The colored areas indicate market conditions: dark green for Favorable, light green for Balanced and red for Hostile.

Understand that we are measuring probabilities here, not certainty. Favorable does not come with a guarantee of a Bull Market nor does Hostile come with a guarantee of a Bear Market.

New Strategy For Hostile Market Conditions

The refinements to the Market Conditions Model which provided identification of Hostile market conditions; enabled TAAS to build a Tactical Asset Allocation strategy which improves returns during Hostile markets. While many Bear Market portfolios either go to cash (which decimates returns) or short equities (which increases risk and volatility); the Global Strategy (Hostile) uses a carefully selected basket of Fixed Income funds and Targeted Volatility to provide significant returns while reducing risk.

While market conditions do not exactly coincide with the SPDR 500 trajectory, the Market Conditions Model driven Strategy selections, have done very well under all three market conditions while delivering on the goal of of significantly lower risk:

“Compound Annual Growth Rate” represents the average annual return during each period. “Maximum Monthly Drawdown” describes the maximum loss in portfolio value, from high to low, the investor would see across the most adverse series of monthly portfolio statements.

Investment strategies which have provided returns of twice the maximum drawdown, and do so without use of leverage or other high risk gimmicks, are incredibly rare.

Strategies For All Market Conditions

TAAS now has a Tactical Asset Allocation strategy based on low-cost exchange-traded funds (ETFs) for each of the three market conditions encountered during a full market cycle. The ETF portfolios (fund baskets) range across equities, fixed income instruments, commodities and cash. These strategies adjust the proportion of assets in a portfolio (portfolio composition) to minimize the probability of large losses, while at the same time, maximizing the potential for higher returns.

The chart below compares the performance of the TAAS Global Strategies to the S&P 500 and to the Vanguard Balanced Index Fund for a full market cycle beginning with the 2007 Bear Market. The S&P 500 (-46%) and Vanguard Balanced Index Fund (-30%) not only suffered very large Bear Market losses but required years to recover those losses.

The TAAS Global Strategies not only held their value during the Bear Market, but grew in value. That provided a significant head start when the Bull Market returned. And Bull Market performance has significantly outpaced the benchmarks.

(Month by month returns for each strategy are available in the tables included on the website Strategies page)

If your current investment strategies are prone to excessive drawdowns like the VBINX and the SPDR 500 or are falling short of the results you want, it’s likely there is be a TAAS Strategy to suit your needs. TAAS Strategies are designed for the confident, self-directed investor who wants to make his or her own investing decisions but is confronted by time constraints or simply wants to offload some investment responsibility.

The TAAS Global Strategies are offered to investors via newsletter subscription.

Anthony de Freitas assisted with the preparation of this article.