Tactical Asset Allocation – December 2021

Tactical Adaptive Strategies Update

Performance

Adaptive Global finished with a gain of 1.26% for the month and gain of 16.98%. The strategy spent the month invested in domestic big caps and cash. Adaptive Global is our most broadly diversified “go anywhere” strategy with a 20+ year CAGR of 14.9%, a very modest maximum drawdown of 7.7%, and a low 9.4% standard deviation of monthly returns.

Adaptive Income was unchanged and finished the year with a gain of 7.26%. With a 20+ year CAGR of 9.8%, this strategy captures $6+ dollars of gain for every $1 in loss. It sports our lowest maximum drawdown of 3.9% and our lowest volatility with a standard deviation of just 4.3%.

Adaptive Innovation finished with a loss of 9.21% for the month and 11.31% YTD. Adaptive Innovation was invested in a combination of innovation and Treasuries. This was our first niche strategy intended to be used for a very small portion of a diversified portfolio. It sports a 6 year CAGR of 21.1%, maximum drawdown of 18.1%, and standard deviation of 17.3%.

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

Perspective

Risk Off (Again)

The Tactical Model’s Adaptive Dynamic Momentum algorithm  calculates TrendScores for each of the funds used in the TAAStrategies. In assigning a TrendScore, the algorithm examines a wide range of periods for which it calculates momentum, volatility, and statistical confidence .

As of mid-day Wednesday, just half of the ETFs used in the TAAStrategies have positive trends. Of the half which have positive trends, just half have high confidence. That leaves us with just a quarter of the TAAStrategies ETFs which are investable with a reasonable probability of positive returns.

TAAStrategies allocations for January reflected the uncertainties.

Year-End Review

I will be posting a longer piece shortly.

Market

From the December 31st Market Monitor

All major indexes except the Broker Dealer were up this week with the greatest strength in Housing and the small and mid cap indexes. While indexes rallied for the final week of the year, volume was typically low and breadth was poor. The S&P 500 came within 2 points of our 4811 price target before pulling back on Friday. We have one higher target remaining at 4897.

This week’s rally was enough to push the VIX Weekly Model to a Buy signal. This model often provides intermediate term signals which last for weeks or longer.

Cumulative Advancing Declining Volume continues to show significant bearish divergences across all S&P indexes plus NASDAQ 100 and 9 of 12 sectors.

The Credit Market Index improved again this week to -50%. While the steady improvement is constructive, we should not lose sight of the fact that credit conditions have tightened and are not confirming the new highs in the S&P 500.

The 10 year Treasury yield, which rose slightly this week,  remains range bound between 1.34% and 1.75%.

The current watch list :

  • The Speculation Index suggests a pause in investor risk appetite
  • The Russell 2000 breakout has failed and the index is now testing the bottom of its long consolidation. This suggests eventual failure.
  • Just three of the seven mega-cap market leaders which have accounted for much of the rally in the big cap indexes are showing relative strength.
  • Big caps appear to have started a shift from growth to value thereby joining the small caps.
  • Consumer Staples is much better bid than Discretionary which is risk off
  • Inflation expectations rose this week
  • Overall market breadth is lagging the market with increased concentration among the mega caps
  • For the past 30 days, the S&P 500 shows 8 Distribution Days (0.2% decline on higher volume) and 2 Accumulation Days (1% rally on higher volume). The consistency with which Distribution Days lead Accumulation Days is concerning.
  • The VIX levels and signals are mixed but showing some positive divergences

Following a fabulous 2021, everyone wants to know what the market will do in 2022 and the talking heads oblige for forecasts. I think probabilities are more useful.

  • The S&P 500 closed the year at 4+ standard deviations above its regressions from major lows in 1932, 1982, and 2009 and the probabilities of remaining there are well under 1%.
  • Price action has been defying poor breadth as measured by Cumulative Advancing Declining Volume for many months; a condition which is not sustainable on a long term basis. Either breadth improves markedly or the equity market is extremely likely to enter a significant correction.
  • The Credit Market Index remains negative which indicates tightening credit conditions across domestic and global markets and investment grade to junk. This suggests that the leverage and speculation which has helped drive this market to record valuations is unlikely to continue at the same pace.

Overall, the probabilities appear to favor the downside until breadth and credit market conditions improve.

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 most recent market cycle covers January 2020 to date. Results for this market cycle are actual.

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 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 most recent market cycle covers January 2020 to date. Results for this market cycle are actual.

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 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)