Tactical Asset Allocation – August 2022

Tactical Adaptive Strategies Update

Performance

Adaptive Global spent the month in cash and shows a gain of 0.15% YTD.  Adaptive Global is our most broadly diversified “go anywhere” strategy with a 22+ year CAGR of 14.5%, a modest maximum drawdown of 7.7%, and a low 9.3% standard deviation of monthly returns.

Adaptive Income spent the month in high yields and shows a loss of 1.51% for the month and 3.58% YTD. With a 22+ year CAGR of 9.3%, this strategy captures nearly $5+ dollars of gain for every $1 in loss. Adaptive Income sports our lowest maximum drawdown of 4.4% and our lowest volatility with a standard deviation of just 4.3%.

Adaptive Innovation has been in cash since March 1 and shows a loss of 2.76% YTD. This is a niche strategy intended to be used for a very small portion of a diversified portfolio. Adaptive Innovation sports a 6 year CAGR of 18.4%, maximum drawdown of 20.3%, and standard deviation of 16.6%.

The S&P 500 finished with a loss of 4.08% for the month and a loss of 16.18% YTD. It has a 22+ year CAGR of 6.4%, maximum drawdown of 50.8%, and standard deviation of 15.2%.

The Vanguard Total Bond Market Index Fund (entirely investment grade) finished with a loss of 2.96% and shows a loss of 11.10% YTD. It has a 22+ year CAGR of 4.0%, maximum drawdown of 13.2%, and standard deviation of 3.8%.

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

Perspective

Market

The past 8 months have not been kind to the markets. The S&P 500 is down 16%, the Vanguard Total Bond Fund (exclusively investment grade) is down 11% and the Vanguard Balanced (60/40) Index Fund is down 14%.

Across 22 years of history beginning with 2000 and ending in 2021, Adaptive Global has never spent a month entirely in cash. During 2022, Adaptive Global Strategy has spent 2 months in cash. Of the six months it has been invested, half were up and half were down for a net 0.15% gain.

Across the same 22 years of history ending in 2021, Adaptive Income spent 1 month in cash during each of 3 years: 2004, 2013, and 2015. Adaptive Income has spent 4 months in cash this year and would have avoided a 3.58% loss had it spent the other 4 months in cash.

Adaptive Innovation has a much shorter history beginning with November 2015; however it too never spent a month in cash through 2021. This year, Adaptive Innovation has spent 6 months in cash and would have avoided a 2.76% loss had it remained in cash for the other 2 months.

Perhaps the most exceptional characteristic of this year’s bear market has been the total absence of inverse correlation between equities and fixed income which has been the very foundation of portfolios variously referred to as “balanced” or “diversified”. An essential characteristic of these portfolios is the reliance upon rising fixed income prices to offset some or all of the equity losses during a bear market.

In short, both equities and fixed income are in bear markets. We are indeed in a rare time in the markets!

Adaptive Global vs Adaptive Income

While both Adaptive Global and Adaptive Income have significantly outperformed equity and fixed income benchmarks, Adaptive Global has outperformed Adaptive Income. How do they differ?

  • Adaptive Global uses a basket of 32 funds covering equities, fixed income, real estate, commodities and precious metals while Adaptive Income uses a basket of 6 fixed income funds. Adaptive Global’s broader basket has a higher probability of finding funds which are likely to outperform the market.
  • Adaptive Income uses relatively short momentum measures which make the strategy more agile in entering and exiting fund positions. This has historically worked to the advantage of Adaptive Income in minimizing both volatility and drawdowns.
  • Adaptive Global uses relatively longer momentum measures coupled with signals from the Market Conditions Model to select the appropriate basket of funds. Each fund basket consists of Exchange Traded Funds which have been carefully selected and validated for a specific market condition. This combination has historically provided higher returns.

Market Condition

The Market Conditions Model which shifted to Hostile for the month of May, remains Hostile. Our whitepaper “What Is A Market Conditions Model? How Does It Lower Risk?” provides a succinct summary of what this means for investors.

Market Monitor

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 September 2nd Market Monitor

All major indexes were down for the week led by the small caps as they caught up to the downside with the big caps. The S&P 500 favored and then exceeded last week’s downside target of 3828. While the short term momentum has remained oversold for two weeks now; the intermediate term momentum is still falling and probably has another couple of weeks before reaching oversold levels. The intermediate term target for the S&P 500 is 3428 while the short term target is 3798 both of which are below this week’s close at 3924..

Cumulative Advancing Declining Volume deteriorated this week confirming the decline. Volume and/or Issue advance/decline ratios for the past 10 days have reached extreme negative levels as has the daily McClellan Oscillator.  That said, CADV is confirming the decline which suggests an eventual new low.

The Credit Markets Index declined sharply this week from +40% to -13% indicating that investors are shifting rapidly to risk off under tighter financial conditions. Delinquency rates have risen noticeably.

The 10 year Treasury yield rose sharply this week to 3.30%. While the technicals have been pointing to a 3.94% target, the market has been slow to accept the prospect of higher rates.

Across other metrics:

  • Consumer sector preferences have shifted from discretionary to staples (risk off)
  • Value is starting to outperform growth (risk off)
  • The Speculation Index has turned down (risk off)
  • Previous big tech market leaders are lagging (risk off)
  • The VIX models and indexes are bucking the bearish trend

The combination of oversold momentum and extreme negative levels in declines should prove supportive of a rally next week although the rally is unlikely to reverse the intermediate trend from bearish to bullish which would require a weekly close above 4280. A weekly close below 3675 is a bear market continuation signal.

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)