Tactical Asset Allocation – April 2020

Tactical Adaptive Strategies Update

Performance

Adaptive Global gained 1.07% for April and has lost 5.17% YTD. Adaptive Global turned in a nice gain on a mix of bonds and precious metals.

Adaptive Income gained 0.27% for April and 2.10% YTD. Adaptive Income provided money market-like returns from short term Treasuries.

Adaptive Innovation gained 0.51% for April and 2.84% YTD. Adaptive Innovation turned in a nice gain on a ladder of short, medium, and long term Treasuries

SPY (S&P 500 ETF) gained 17.7% for April and lost 9.19% YTD

 

Perspective

There is not a lot to add to what I said last month:

The market crash became possible due to a mountain of excess. Excessive corporate debt used to fund stock buybacks. Excess in the issuance and rating of “covenant lite” bonds and loans. Excess in Federal spending and deficits. Excess in equity valuations to historically high extremes. And excessively cheap money intended to prevent the natural business cycle from cleansing the whole lot.

Absent this mountain of excesses, there could have been no avalanche. We are about to see if the unleashing of record deficit spending (aka Modern Monetary Theory) coupled with a ballooning Federal Reserve balance sheet and virtual nationalization of the credit markets can hold the wolf at bay.

In one way or another, we will get through this crisis. It’s not likely to be pretty and the odds of markets returning to the “way it was” are next to nil. As always, there will be opportunities. Among those opportunities, I see a surge in innovation driven by the challenges of the crisis and post-crisis periods coupled with a resurgence of local manufacturing.

The Fed and Congress have quite literally shocked the fiscal and monetary systems into submission even as the shuttered economy and businesses plumb depths for which we have yet to see the bottom. This is a time for caution and to maintain liquidity.

Global Adaptive update

In last month’s letter, I mentioned that I would be reviewing the use of the Emerging Markets ETF under Balanced Market conditions.

To better perform the review, I developed a new tool which provides improved statistical analysis of ETF performance within each market condition. The review showed that VWO’s contribution to risk is higher than its contribution to reward. In short, we would have been much better off without using it under Balanced market conditions.

I then undertook a comprehensive review to measure performance and risk/reward of each ETFs under each market condition. By raising the bar on risk/reward thresholds and strategy contribution levels, I was able to significantly improve overall performance as well as consistency of returns from month to month and year to year.

No changes were made to any of the trend, selection, or weighting algorithms.

Upon running each of the two market cycles separately, I was very pleased to note a high degree of consistency:

  • Jan 2000-Sep 2007: CAGR @ 15.1%, MaxRD @ 7.2%, Ulcer @ 3.7%, Up/Down @ 252%
  • Oct 2007-Apr 2020: CAGR @ 14.1%, MaxRD @ 7.7%, Ulcer @ 3.3%, Up/Down @ 241%

This is the performance table for the upgraded Global Adaptive across the two full market cycles:

Performance Table For The Tactical Adaptive Global Strategy From 2000 To Now (Two Full Market Cycles)

The upgraded Global Adaptive strategy will be used for the next rebalance at the end of May.

Market

From the April 24th Market Monitor

“All indexes declined slightly this week except for the Russell 2000 which was up slightly. I’m seeing some evidence of interest in small and mid caps. If the interest persists, it would represent a constructive broadening of the equity market. 

Cumulative Advancing Declining Volume grew a bit more negative on both a weekly and monthly basis. Small and mid caps are slightly positive on a weekly basis and the energy and materials sectors are strongly positive on a weekly basis. The overall tone is negative.

The credit market has continued to improve and I’ve begun recognizing some trend changes as a number of the spreads and yields have declined by more than half of the rise. Still, an index of -38% is not bullish and the credit markets are extremely unlikely to return to the previously favorable conditions in the high yield sector which were so supportive of speculative interest in equities.

The volatility index for the S&P 500 remains elevated at 36 (down from 38) as is the index for the Russell 2000 which declined from 53 to 45. These volatility levels continue to render the market as untradeable for investors.

In the larger picture, the S&P 500 has entered a zone between 2883 and 3023 which has a high probability of turning back the rally. This zone includes two major gaps and the 62% retracement of the decline as well as the 200 day moving average to which I pay little attention but many do. Will the subsequent decline make a new low? Absent the extraordinary intervention of the Fed, I would say yes; however that intervention likely remains too fresh and too active to permit a lower low. We may see a lower low at some point in the future.

While not a technical observation, I have trouble believing that the market will prove capable of moving much higher. While some easing of closures is to be expected, the economic damage is likely to remain with us for longer than most hope. There is no V or U shaped recovery ahead. In fact, we can probably expect a couple of years of markets which cycle up and down sideways rather than trend higher.

Expect a period of time that favors market timing and risk discipline.”

 

Earl Adamy

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Compares performance of the Tactical Adaptive Strategies to the S&P 500 and Vanguard Balanced Index Fund

Supporting tables for Tactical Adaptive Global. S&P 500 (SPY) and Vanguard Balanced Index Fund (VBINX) can be found below

Our backtest results tables are constructed for two full market cycles beginning in January 2000.

The most recent market cycle covers October 2007 to date. The fund baskets for our tactical strategies are constructed from indexed Exchange Traded Funds (ETFs) with just two exceptions, an Open End Fund and a Closed End Fund, both with long history.

The earlier market cycle covers January 2000 through September 2007. A number of the ETFs we use were not created until later in the decade. For those cases, we infill using predecessor Open End Funds (OEFs) for which the indexing and/or subclass is substantially similar to the ETF. Aside from providing insight into possible strategy performance during a second, earlier, cycle, they also offer the advantage of completely out of sample data. The fact that the metrics of both cycles are very comparable appears to validate the process.

We have been asked if it is possible to extend backtests to earlier decades. While this appears to be a common practice with some services; it is not possible to produce credible results for many strategies due to the lack of funds with substantially similar indexing and/or subclass. Doing so would force me to stretch the term "substantial" far beyond my comfort level.

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.

Benchmark S&P 500 (SPY)

Benchmark Vanguard Balanced Index Fund (VBINX)

Compares performance of the Tactical Adaptive Strategies to the S&P 500 and Vanguard Balanced Index Fund

Supporting tables for Tactical Adaptive Income, S&P 500 (SPY) and Vanguard Balanced Index Fund (VBINX) can be found below

Our backtest results tables are constructed for two full market cycles beginning in January 2000.

The most recent market cycle covers October 2007 to date. The fund baskets for our tactical strategies are constructed from indexed Exchange Traded Funds (ETFs) with just two exceptions, an Open End Fund and a Closed End Fund, both with long history.

The earlier market cycle covers January 2000 through September 2007. A number of the ETFs we use were not created until later in the decade. For those cases, we infill using predecessor Open End Funds (OEFs) for which the indexing and/or subclass is substantially similar to the ETF. Aside from providing insight into possible strategy performance during a second, earlier, cycle, they also offer the advantage of completely out of sample data. The fact that the metrics of both cycles are very comparable appears to validate the process.

We have been asked if it is possible to extend backtests to earlier decades. While this appears to be a common practice with some services; it is not possible to produce credible results for many strategies due to the lack of funds with substantially similar indexing and/or subclass. Doing so would force me to stretch the term "substantial" far beyond my comfort level.

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.

Benchmark S&P 500 (SPY)

Benchmark Vanguard Balanced Index Fund (VBINX)

Compares performance of the Tactical Adaptive Strategies to the S&P 500 and Vanguard Balanced Index Fund

Supporting tables for Tactical Adaptive Innovation, S&P 500 (SPY) and Vanguard Balanced Index Fund (VBINX) can be found below

The Innovation ETFs used in the Innovation Strategy were not established until 2014-2015 so our history is limited. There are no predecessor funds which are similar enough to use for infill.

A Caveat

A 35+ year secular bull market in both equities and bonds began in 1982. The last cyclical bull market in equities (and to a lesser extent, bonds) began 10 years ago. Returns during these periods have been historically exceptional. Market returns for the next 10 years are highly unlikely to approach those of the past 10. In fact, there is at least some evidence that market returns have a high probability of being significantly lower and that bonds and equities (which have risen together) may actually begin working at cross purposes.

Investors should not use the statistics shown for our strategies to establish expectations of specific levels of returns or drawdowns. Investors should, however, appreciate that we believe the principles which underlie the Tactical Adaptive Global, Tactical Adaptive Income, and Tactical Adaptive Innovation Strategies are enduring enough to significantly outperform the market in the future, both in lowering risk and in improving returns.

Benchmark S&P 500 (SPY)

Benchmark Vanguard Balanced Index Fund (VBINX)