Tactical Asset Allocation – December 2020

Tactical Adaptive Strategies Update

Performance

All three strategies finished 2020 with a flourish.

Adaptive Global finished with a gain of 5.16% for December and 14.95% for 2020. Gains were led by overweight positions in Asia Pacific equities and commodities.

Adaptive Income finished with a gain of 1.70% for December and 9.78% for 2020. Adaptive Income was invested entirely in municipal high yield bonds.

Adaptive Innovation finished with a gain of 5.99% for December and 34.38% for 2020. Investments were split between the ARK Innovation funds and Treasuries used to manage volatility.

Perspective

Month after month I’ve been writing that “All 3 Tactical Adaptive strategies continue to outperform the S&P 500 on a risk adjusted basis”. While this statement can be readily verified by viewing the 20+ year performance tables I update each month, I thought it would be informative to compare all three Tactical Adaptive strategies to the S&P 500 for this past year which uniquely included both a furious bear market and a (seemingly) invincible bull market:

Tactical Adaptive Global

  • CAGR @ 14.9%
  • Max Monthly Drawdown: 4.2%
  • Ulcer Index: 1.9%
  • Standard Deviation: 12.7%
  • Upside/Downside: 308.9%

Annual return 19% below S&P 500, drawdown 78% below S&P 500, much higher return per dollar risked at $3.09, Ulcer Index and Standard Deviation less than half of S&P 500

Tactical Adaptive Income

  • CAGR @ 9.8%
  • Max Monthly Drawdown: 0.5%
  • Ulcer Index: 0.2%
  • Standard Deviation: 3.3%
  • Upside/Downside 1040.4%

Annual return 47% below S&P 500, drawdown 99% below S&P 500, much higher return per dollar risked at $10.40, Ulcer Index and Standard Deviation at small fractions of S&P 500

Tactical Adaptive Innovation

  • CAGR @ 34.4%
  • Max Monthly Drawdown: 4.9%
  • Ulcer Index: 2.7%
  • Standard Deviation: 21.2%
  • Upside/Downside 421.3%

Annual return 87% above S&P 500, drawdown 75% below S&P 500, much higher return per dollar risked at $4.21, lower Ulcer Index and Standard Deviation

S&P 500 ETF (SPY)

  • CAGR @ 18.4%
  • Max Monthly Drawdown: 19.4%
  • Ulcer Index: 6.9%
  • Standard Deviation: 24.6%
  • Upside/Downside 170.2%

Lowest return per dollar risked at $1.70, highest drawdowns, highest Ulcer Index and Standard Deviation

While 2020 has been favorable for our tactical strategies, not every year will demonstrate such clear-cut advantages. It is critical to keep in mind that our tactical strategies are designed to deliver higher returns with lower risk across full market cycles, not just a single year. See the tables at the end of this post for 21 years of detail.

Subscribers are provided with the opportunity to combine these strategies in a manner which best suits their individual comfort zone of risk/reward.

Revisiting Tactical Adaptive Innovation

Last month’s letter made the case for increased exposure to Tactical Adaptive Innovation. I ran across a graph this month which makes a strong case for some caution.

When I began developing Innovation in 2019, the five ARK Innovation Funds had roughly $2 billion in Assets Under Management. During the past year, AUM have grown 10-fold from a little over $3 billion to $33 billion.

Late in the year, inflows were reaching a billion dollars a day. As ETFs, the ARK Funds can not be closed to new investment. As inflows rise, the ARK Funds are forced to buy more of the same/similar stocks and create more ETF shares. While this has reinforced the rise in ARK fund shares along with the prices of the shares in which they invest; this mania can not end well for ARK or the companies into which they are pouring money.

We will not be increasing our investment to the Innovation strategy until a meaningful correction takes place in the ARK Funds.

Market

From the January 1st Market Monitor

"The big caps had a good week with the S&P 500 up 1.8%; however mid and small caps fell slightly. Both the Broker Dealer and Banking indexes have been improving while the Housing index continues to weaken. The only sector which continues to show strength is materials.

Cumulative Advancing Declining Volume spent most of the week in distribution although it improved on 2 and 10 week comparisons. Improvement aside, CADV continues to show a significant divergence from price across the big and mid cap indexes. Only the small cap CADV continues to confirm the rally in small caps.

The Credit Markets Index improved a bit this week on a resumption in decline of several high yield spreads. While spreads over Treasuries are clearly compressed to excess, there is no sign that spreads are rising which would signal increased risk aversion by investors.

The 10 Year Treasury Yield has stabilized above 0.9% and appears to be showing a propensity to move toward 1.5%.

Gold appears to be on the cusp of a move higher after closing above the downtrend line from the early August high

While both the equity and credit markets remain in decent shape, the extreme valuations scream high risk and are at levels which are supportive of fast and furious declines. Declines in price momentum coupled with deterioration in CADV suggests this is an excellent time to shift attention toward managing downside risks."

I want to wish all of my subscribers and readers a healthy, happy and prosperous 2021.

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)

This strategy is intended to capitalize on trending moves in both precious metals and bitcoin if and when they occur while managing volatility to reduce risk. The strategy, which uses a basket of precious metals, bitcoin, and Treasury funds, selects the single best fund each month although it provides blended allocations when necessary to manage volatility.

Bitcoin is a relative newcomer to investable assets and we take no position as to whether bitcoin is or is not a sustainable asset class. The Grayscale Bitcoin Trust used in this strategy was not established until 2015 so our history is limited. There are no predecessor funds which are similar enough to use for infill.

The CAGR in 2017 is extraordinary; however the bitcoin trust rose 1893% from $1.17 to $22.15 during this period. While the strategy remained invested in bitcoin for 10 of the 12 months, volatility weighting significantly reduced the weighting to bitcoin from a low of 14.6% to a high of 68.0%. The use of Treasuries to manage bitcoin volatility accounts for the high percentage invested in fixed income assets.

Volatility weighting has little effect on precious metals which typically receive a 100% weight when selected.