Tactical Asset Allocation – April 2022

Tactical Adaptive Strategies Update

Performance

Adaptive Global finished with a gain of 1.41% for the month and gain of 3.53% YTD. The strategy spent the month invested in commodities and cash. Adaptive Global is our most broadly diversified “go anywhere” strategy with a 22+ year CAGR of 14.9%, a very modest maximum drawdown of 7.7%, and a low 9.3% standard deviation of monthly returns.

Adaptive Income finished unchanged for the month and shows a loss of 0.98% YTD. It spent another month in cash avoiding the continued carnage in fixed income. With a 22+ year CAGR of 9.6%, this strategy captures nearly $6+ dollars of gain for every $1 in loss. Adaptive Income sports our lowest maximum drawdown of 3.9% and our lowest volatility with a standard deviation of just 4.3%.

Adaptive Innovation finished unchanged for the month and shows a loss of 2.76% YTD. It spent another month in cash. This is a niche strategy intended to be used for a very small portion of a diversified portfolio. Adaptive Income sports a 6 year CAGR of 19.4%, maximum drawdown of 20.3%, and standard deviation of 17.0%.

The S&P 500 finished with a loss of 8.78% for the month and a loss of 12.99% YTD. It has a 22+ year CAGR of 6.7%, maximum drawdown of 50.8%, and standard deviation of 15.1%.

See the strategy descriptions, charts, and tables below or on the Strategies page.

Perspective

High Valuations

“Since 2009, the belief that “low-interest rates justify high valuations” was the primary catalyst supporting the “this time is different” narrative. However, with interest rates now rising, the support for overvaluation is at risk. Historically, the Federal Reserve hikes rates until “something breaks,” which resolves the overvaluation problem. (i.e., prices fall sharply.)” - Lance Roberts

The Earnings Yield of a stock with a PE ratio of 50 is 2%. When speaking in bond terms, ultra high PE stocks are referred to as long duration as in a very long term bond. The difference of course between Equity Yield and Bond Yield is the risk profile; however the two are still coupled at the hip as competitors for investment dollars. When Bond Yields rise, Earnings Yields also rise which lowers the PE. The higher the PE, the greater the leverage in duration. That explains why high growth stocks do very poorly in an environment where bond yields are rising.

On Facing An Uncertain Future

There has been no shortage of talking heads ranging from FOMC members to economics to market timers; each expounding upon their views of the future. Inflation will be up. Inflation will be down. Recession ahead. No recession. Yields are still higher. Yields are about to turn lower. Equities still in a bull market. Equities headed for a major bear market.

How to deal with all of this? Should we continue using the TAAStrategies or simply retreat into cash?

I am in the process of writing a detailed blog post which will address these questions using our historical data which stretches back to the beginning of 2000. I hope to publish it by mid-May.

I have already built the statistical abstract for Adaptive Global. It examines a total of 25 periods across 8 major conditions and provides both the Compound Annual Growth Rate (the rate of growth during the period) and the Maximum Drawdown for each period.

  • Inflation up/down (5 cases): CAGR 10.4% to 23.6% and MaxDD 3.4% to 7.7%
  • Recession/No Recession (6 cases): CAGR 2.7% to 19.0% and MaxDD 0% to 7.7%
  • Rising/Falling 10 Year Treasury (8 cases): CAGR 6.3% to 27.2% and MaxDD 2.9% to 7.7%
  • Bull/Bear market (6 cases): -7.4% to 19.8% and MaxDD 2.9% to 7.7%

The one period with negative CAGR (-7.4%) occurred during the Jan-Mar 2020 bear market.where the MaxDD was just 2.9%.

I have yet to find another investment process which has provided this level of performance and risk control across such a wide variety of conditions.

Market

Note: Market Monitor is a structured weekly process of compiling and analyzing critical information about the health of the markets. I've been doing this for nearly four decades. These are personal observations which have no effect on the TAAStrategies.

From the April 29th Market Monitor

All major indexes declined this week led by two of our canaries: Banking down 5.2% and Broker Dealer down 4.7%. The intermediate term trend indicators have moved to neutral/bearish on all major indexes except the S&P 100 and S&P 500 which remain bullish. The short term trend indicators have moved to neutral/bearish on all major indexes. The small cap indexes are showing some bullish divergences. The S&P 500 targets 3975-3988.

Cumulative Advancing Declining Volume is showing bullish divergences to price declines for the S&P 500, 400, and 600 indexes.

The Credit Market Index declined this week as spreads to Treasuries have widened. We are looking to the credit markets to provide hints regarding the next act in the equity market. The hints are not constructive.

The 10 year Treasury yield declined 0.02 this week. The next significant target is 3.32%, just slightly above the previous major (post 2011) high at 3.22%. The MOVE Index, a measure of volatility in the Treasury market, is signaling significant liquidity issues which are unlikely to improve with higher yields and Fed balance sheet reduction.

The current watch list :

  • The Speculation Index has fallen sharply in a shift to risk off
  • The Russell 2000 has failed in its attempt to rally through the previous long consolidation
  • The five mega cap (former) market leaders are all declining.
  • Value (risk off) continues to lead growth
  • Consumer Staples is vastly better bid than Discretionary which is risk off
  • Investor inflation expectations remain extremely high
  • Overall market breadth is mixed with big caps being the only bright spot
  • VIX levels have confirmed this week’s decline in the Russell and NASDAQ 100 indexes.

High inflation, high rates, and high energy costs appear to be creating a significant drag on the equity market. Risks remain to the downside. The 3975-3988 target zone in the S&P 500 is a key area to watch for a possible rebound supported by a modest set of bullish divergences. Should the market fail to capitalize on this potential opportunity, we will enter our next bear market.

Thank you for reading.

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 results tables are constructed for three full market cycles beginning in January 2000.

The Adaptive Global table shows backtested results through July 2018 followed by actual results. More information is available in the blog article: The TAAStrategies, A Short History.

The most recent market cycle covers January 2020 to date.

The second market cycle covers October 2007 through December 2019. The Adaptive Global and Adaptive Income strategies were developed using the first 10+- years of data from this cycle while the final years are actual.

The third market cycle covers January 2000 through September 2007. This market cycle was used to provide out of sample validation of strategy results from the second market cycle. The fact that the return and risk metrics for the third cycle are statistically comparable to those for the second cycle validates the process.

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. A number of the ETFs we use were not created until 2007+. In each case, we infill using predecessor Open End Funds (OEFs) for which the indexing and/or subclass is substantially similar to the ETF.

We have been asked if it is possible to extend backtests to the 1970’s. While a few publishers attempt this; we believe it is not possible to produce credible results for all but the most basic TAA strategies due to the lack of funds with substantially similar indexing and/or classification. Doing so would force me to stretch the term "substantial" far beyond my comfort level.

A blank month indicates that the strategy was in cash.

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 results tables are constructed for three full market cycles beginning in January 2000.

The Adaptive Income table shows backtested results through June 2019 followed by actual results. More information is available in the blog article: The TAAStrategies, A Short History.

The most recent market cycle covers January 2020 to date.

The second market cycle covers October 2007 through December 2019. The Adaptive Global and Adaptive Income strategies were developed using the first 10+- years of data from this cycle while the final years are actual.

The third market cycle covers January 2000 through September 2007. This market cycle was used to provide out of sample validation of strategy results from the second market cycle. The fact that the return and risk metrics for the third cycle are statistically comparable to those for the second cycle validates the process.

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. A number of the ETFs we use were not created until 2007+. In each case, we infill using predecessor Open End Funds (OEFs) for which the indexing and/or subclass is substantially similar to the ETF.

We have been asked if it is possible to extend backtests to the 1970’s. While a few publishers attempt this; we believe it is not possible to produce credible results for all but the most basic TAA strategies due to the lack of funds with substantially similar indexing and/or classification. Doing so would force me to stretch the term "substantial" far beyond my comfort level.

A blank month indicates that the strategy was in cash.

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.

The Adaptive Innovation table shows backtested results through June 2019 followed by actual results. More information is available in the blog article: The TAAStrategies, A Short History.

A blank month indicates that the strategy was in cash.

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)