Tactical Asset Allocation – February 2020

Tactical Adaptive Strategies Update

Performance

Adaptive Global lost 3.61% for February and lost 5.76% YTD

Adaptive Income gained 1.58% for February and gained 2.36% YTD

Adaptive Innovation gained 0.96% for February and gained 7.63% YTD.

Adaptive Global rose steadily during February to 2.4%+- before Cv19 reality began to set in. It was the large allocation to investment grade bonds and precious metals which moderated the 7.92% decline in the S&P 500.

Adaptive Income declined during February to -.5% before Cv19 reality began to set in.

Adaptive Innovation soared during February to an eye popping gain of 15.2%+ before Cv19 reality began to set in. The volatility of our Innovation ETFs has gotten so high that the Tactical Model has hedged the selections for March.

Cautions

On December 18, I sent out a rare email titled “Important Risk Management Adjustment” in which I wrote:

“I am writing to share with you the reasons why I'll be making a significant adjustment to our TAAS portfolio today (December 18). The last time I wrote something along these lines was in the rebalance letter which went out on December 29, 2017: "With this Rebalance, I will be reducing our TAAS allocation to 60% until the major indexes correct or decline enough to bring momentum measures within historical bounds." 

Given the huge (and growing) monetary and fiscal largess, the SPX could continue on for another thousand points but I kind of doubt that. My work suggests there may be another 115 points (3.62%) ahead in the SPX to 3308. It also suggests even higher odds of a 10%+ decline.”

For better than two months, it looked like I’d have egg on my face as the S&P 500 subsequently rose to 3393. But then, in just 7 days, the S&P 500 fell 16% to 2856.

I sent out another email with the January rebalance letter in which I wrote:

“I am shifting my entire allocation to Adaptive Income for February which is all in AGG.

The risks attendant with the Wuhan coronavirus remain unquantified but are clearly growing. While the health risks appear substantial, it is the economic risks which are skyrocketing and have my undivided attention.

China is a key and major player in the global economy. The effects of shutting cities, factories, ports, and shipping are going to be significant regardless of how the virus itself plays out.

I do not want to own any equities in this environment.”

Again, it looked like I was leaving a lot on the table as Adaptive Global rose 2.4% and Adaptive Innovation rose an incredible 15%+. But as we close in on month-end, Adaptive Income was the largest gainer.

I don’t do market forecasts. The Tactical and Market Conditions Models do not do forecasts.

The whole point of using the Tactical and Market Conditions Models is to identify the probabilities of risk and reward and make the most of those probabilities.

For more than three decades, I’ve been performing a structured weekly process of compiling and analyzing critical information about the health of the markets. I share a summary each week on the Market Monitor page. On rare occasions, I feel strongly enough about risks or opportunities to share them via a special email.

I have tremendous confidence in the ability of the Tactical and Market Conditions Models to lower risk and improve returns over a full market cycle. I believe our Strategies to be the best available anywhere. That said, I also believe that the human brain can assemble and interpret information in a manner which models can not. It is my purpose to provide the best of both to my subscribers.

We have three Strategies to which we can tailor our allocations to suit our risk tolerance. Our ability to deploy these strategies in a constructive manner will prove critical in navigating the challenges which lie ahead.

Coronavirus

I am reading a lot of Cv19 material by highly respected medical and research people with links to supporting research. Few useful facts are making it into the media. Here are a few insights which may prove useful:

  • There are two China’s: Hubei province and the rest of China. Hubei is a basket case while the rest of China appears to be recovering slowly.
  • Global logistics: ports, ships and containers, are in disarray. It will take a month or so to put them back in order.
  • The stunningly slow rollout of Cv19 test kits in the US will likely result in a surprising and unexpected surge in Cv19 infections.
  • Cv19 is expected to infect a fairly large portion of the global population, as much as 40%. The US will not be spared and delayed testing will likely result in a major surge in cases over the next two weeks.  Mortality rates remain in flux but are estimated at between 1% and 2%, strongly skewed toward older males with heart, lung, and diabetes conditions estimated in the 8% to 14% range. A major ray of hope comes from the city/state of Singapore which has been very aggressive in identification and treatment of over 100 cases with 0 mortality (to date).
  • Work absences will result in measurable loss of productivity in all sectors for several months.
  • Social disengagement, a major aspect of prevention, will result in measurable sales and revenue reductions in sectors including shopping, eating, travel, and entertainment.
  • To date, there are few signs that the substantial costs of testing, treatment, quarantine, and isolation will be funded by the government which may lead to substantial and unexpected family medical costs.
  • The growth and extreme levels of debt financing have become epidemic. Corporations and businesses which are loaded with debt are going to come under severe stress as the fallout from Cv19 spreads.

In short, the social and economic impacts of Cv19 will be significant but at this point remain largely unknown. However the country and world will manage to get through it although the bruises are likely to be very severe.

Market

From the February 28th Market Monitor

“All major indexes declined 10% to 15% this week with the S&P 500 declining by 11.5%. While weekly momentum remains bullish, daily momentum has turned bearish and is deeply oversold. This week’s low of 2856 in the S&P 500 was 16% below its all time high of 3393.

Cumulative Advancing Declining Volume finished the week with a bullish divergence to price suggesting a rally should find some legs.

In the credit markets, domestic and international yield spreads turned up sharply except for investment grade. It’s too early to determine if the high spreads will stick or even widen further. An extended period of higher spreads will bleed into both the bond and equity markets.

Gold fell hard this week from extremely overbought conditions.

Jan 31 sell signals from the ValueLine Weekly and VIX Models remain in place.

The was the steepest sell-off from an all-time-high I can find going back to and including 1929. Real damage has been done to the equity market and the bond market is priced to perfection.  It’s too early to rank the probabilities of a longer term recovery; however the shorter term appears primed for a rally.”

Earl Adamy

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Our standard tables are constructed for one full market cycle beginning in October 2007. The fund baskets for our tactical strategies are constructed from Exchange Traded Funds (ETFs) with just two exceptions, an Open End Fund and a Closed End Fund, both with long history. Fund sponsors did not begin the heavy rollout of Exchange Traded Funds until 2005 - 2006 so prior history is often unavailable.

We make extensive use of index funds and most of those have predecessor Open End Funds (OEFs) using the same index,. We use infill from Open End Funds to construct fund "similar" tables for two full market cycles beginning in 2000. In each case where we have used an Open End Fund for infill, we consider the indexing and/or subclass to be substantially similar to the ETF. Aside from providing insight into possible strategy performance during a second cycle, they also offer the advantage of completely out of sample data.

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.

Our standard tables are constructed for one full market cycle beginning in October 2007. The fund baskets for our tactical strategies are constructed from Exchange Traded Funds (ETFs) with just two exceptions, an Open End Fund and a Closed End Fund, both with long history. Fund sponsors did not begin the heavy rollout of Exchange Traded Funds until 2005 - 2006 so prior history is often unavailable.

We make extensive use of index funds and most of those have predecessor Open End Funds (OEFs) using the same index,. We use infill from Open End Funds to construct fund "similar" tables for two full market cycles beginning in 2000. In each case where we have used an Open End Fund for infill, we consider the indexing and/or subclass to be substantially similar to the ETF. Aside from providing insight into possible strategy performance during a second cycle, they also offer the advantage of completely out of sample data.

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.

Our standard tables are constructed for one full market cycle beginning in October 2007. The fund baskets for our tactical strategies are constructed from Exchange Traded Funds (ETFs) with just two exceptions, an Open End Fund and a Closed End Fund, both with long history. Fund sponsors did not begin the heavy rollout of Exchange Traded Funds until 2005 - 2006 so prior history is often unavailable.

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.