Tactical Asset Allocation – December 2023

Tactical Adaptive Strategies Update

Performance

Strategy: Adaptive Global finished the month with a gain of 0.69% and a gain of 0.90% for 2023.  Adaptive Global is our most broadly diversified “go anywhere” strategy with a 24 year CAGR of 13.8%, a low maximum monthly drawdown of 7.7%, and a low 9.3% standard deviation of monthly returns.

Benchmarks: Adaptive Global is a broad strategy that invests in global equities and averages a 36% position in fixed income. The Vanguard World Stock Fund (VT) finished the month with a gain of 5.15% and a gain of 22.02% for 2023. It has a 24 year CAGR of 8.8%, maximum monthly drawdown of 49.2%, and monthly standard deviation of 18.2%. The Vanguard Balanced Index Fund (VBINX) finished the month with a gain of 4.69% and a gain of 17.44% for 2023. It has a 24 year CAGR of 6.1%, maximum monthly drawdown of 32.6%, and monthly standard deviation of 9.8%.

Strategy: Adaptive Income finished the month with a gain of 2.54%% and a gain of 7.06% for 2023.. With a 24 year CAGR of 9.2%, this strategy captures $6 dollars of gain for every $1 in loss. Adaptive Income sports our lowest maximum monthly drawdown of 3.9% and our lowest volatility with a monthly standard deviation of just 4.2%.

Benchmark: The iShares Aggregate US Bond Fund  (entirely investment grade) finished the month with a gain of 3.69% and a gain of 5.65% for 2023. It has a 24 year CAGR of 3.8%, maximum monthly drawdown of 17.1%, and monthly standard deviation of 4.2%.

For details, see the links below to strategy descriptions, charts, and tables or the Insights page.

Perspective

One Extreme to Other

We are seeing radical shifts in directions of both equities and fixed income spaced just a few months apart. The rates of change in both equities and fixed income are historical. These are not normal markets.

Review

As we close 2023, I think it is useful to take a look back at 2023 (Jan - Dec), the current full market cycle (Jan 2022 - Dec 2023), and the history we have for four full market cycles (Jan 2000 - Dec 2023) to see if the strategies are meeting their intended goals as described on our home page.

I have prepared a table with Compound Annual Growth Rates (CAGR) and Maximum Monthly Drawdown (MaxDD) which covers all three periods for both Adaptive Global (light green) and Adaptive Income (light yellow) along with comparisons. (Data is through 12/28/23.)

Several comparisons are included: S&P 500 for the big cap US equity market, Vanguard Total World Stock Index Fund (Adaptive Global includes 5 global equity funds), and Vanguard Balanced Index Fund (Adaptive Global averages 36% invested in bonds). So far, my attempts to identify a truly comparable benchmark which includes global equities, bonds, and commodities, with history back to January 2000 have failed.

Minimize Risk

The first stated goal is to minimize risk. “We spend more time growing portfolios by minimizing the time spent filling in holes. Each decline must be fully recovered before the portfolio can return to growth. You will be hard pressed to find investment strategies with lower drawdowns over a full (Bull/Bear) market cycle.

There is not much which needs to be said here. Tactical Adaptive Income and Tactical Adaptive Global show the smallest drawdowns for each of the periods. The small drawdowns really stand out for the full cycles where they are 40%+- or less of the other funds.

Maximize Returns

The second stated goal is to maximize returns. “We are more effective in maximizing returns by identifying and adapting to changing Market Risk Conditions. Each Market Risk Condition offers a unique opportunity to enhance returns based on the blend of equity, fixed income, and alternative asset classes. Again, you will be hard pressed to find investment strategies with more consistent returns over a full (Bull/Bear) market cycle.

The 2023 returns for Adaptive Global are downright disappointing. Adaptive Global had an unusually large one-month drawdown in February and the year’s two near-vertical rallies did not fall within Adaptive Global’s intermediate term investment windows. Finally, Adaptive Global’s diversification and volatility algorithms preclude taking an oversized position in the Mega-Cap 7 led S&P 500.

Adaptive Income, which typically identifies short term trends, did quite well for 2023. [Yes, we have tested the Adaptive Global fund baskets with the Adaptive Income algorithms. Fixed income requires different algorithms than equities.]

The full cycle returns fully comport with our goal to maximize returns, especially when adjusted for risk.

Concluding thought

The end of the current full market cycle and beginning of a new market cycle may not be that far ahead.

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 December 29th Market Monitor

All major indexes rose slightly this week led by the Broker Dealer index while the big caps lagged a bit.  All major indexes are overbought in the intermediate term and overbought with bearish divergences in the short term. Both intermediate and short term trends are bullish with four indexes targeting new all time highs: S&P 100, Nasdaq 100, Broker Dealer, and Housing.

The S&P 500 recorded its all-time weekly and monthly closing high of 4766 on week and month ending December 31, 2021. The all-time high of 4819 occurred on January 3, 2022. The S&P 500 achieved a new weekly closing high of 4769 this week and is likely to complete the final 26 points required to tag the all time high before starting an overdue correction. Once 4819 is recovered, we will have a new target at 5178.

Small and mid caps are breaking out above their long trading range signaling broader market participation in the rally.

Valuations are extremely stretched with Market Cap at 178% of GDP.

All 5 Market Breadth Ratios (SPX equal weight vs cap Weight, S&P 500 vs S&P 100, Ru2000 vs S&P 500, Nasdaq Comp vs Nasdaq 100, Nasdaq 100 equal weight vs cap weight) continue to improve. This decreases the risk of a near-term rally failure.

Cumulative Advancing Declining Volume was little changed this week with short term CADV at neutral levels and intermediate term CADV at negative levels.

The Credit Market Index improved again this week from a bullish 80% to a bullish 83%.  The Credit Market Index is signaling a significantly loosening in credit conditions in the US and globally. Even the lowest quality CCC and below spreads are declining which signals that credit conditions for smid caps are no longer tightening. Generally, credit conditions are very favorable for equities.

The 10 year Treasury declined another 4 basis points this week to 3.87% at what may prove to be short term support. Major support lies at 3.25% and overhead resistance at 5.0%. Following such a sharp decline we should expect a rise in yield followed by a new trading range for which we have no targets as yet. Upward pressure on bond yields is most likely to come from Treasury issuance.

Across other metrics

  • The ValueLine Weekly and Daily models remain on Buy signals (risk on) Note: the models are catching up to the S&P 500
  • One VIX Model remains on a buy signal while the second shows a bearish divergence (neutral)
  • The Short Term Breadth Model is failing to confirm the later stages of this rally (risk off)
  • My new Offense Defense Indicator is showing offense (risk on)
  • The growth/value ratios have shifted from growth to value (risk off)
  • The Speculation Index is rising (risk on)
  • Big 8 “tech” stocks: 4 are bearish, 4 are bullish (neutral)
  • Inflation expectations are falling (risk on)
  • The 10 year/3 month Treasury spread remains wide at  -1.31% and above its -1.63% low.
  • Petroleum and industrial metals remain in decline while precious metals are getting a bid
  • The US Dollar has broken weekly trendline support, but is oversold

Big caps appear to be headed higher although they are extremely stretched in both momentum and valuation. The Nasdaq 100 and Info Tech sector appears to be capturing the bulk of investor interest. I expect we’ll see new all time highs in both the S&P 500 and the Nasdaq 100. This looks like a blow-off which could reverse sharply shortly into the new year so caution is very much in order.

I have noted the sharp improvements in the Credit Market Index during the past month indicating considerable loosening in credit conditions which did not comport with previously hawkish comments from Powell. While the Fed does not expect to achieve its 2% inflation target until 2026, the Dot Plot shows 3 rate cuts in 2024. I think we have confirmation that the Fed has blinked. We’ll know why in 5 years when the detailed minutes are released. Possibilities include: forthcoming elections or fears of trouble in the Treasury market due to the volume of pending issuance.

I have been warning of the shift from monetary dominance to fiscal dominance for 4 months now. I believe firm evidence is visible across the markets:

  • While Treasury yields have pulled back from their highs, it remains to be seen if this is sustainable in the face of large Treasury issuance
  • The Treasury MOVE index flirted with the 130 level before pulling back to 110+-. It remains remains elevated (above 90) and periodically shoots higher
  • Treasury auctions at the long end of the curve are seeing buyer pushback which is forcing the Treasury to concentrate issuance at the short end of the curve..
  • The price of gold shot 10% from 1824 to a record high just shy of 2100 in just a few week and appears to be nearing a major breakout

While war is always a concern, I believe these shifts have more to do with the growing realization that the growing deficits and rising interest expense represent a threat to both the Treasury and equity markets.

Thank you for reading.

Earl Adamy

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