Tactical Asset Allocation – February 2021

Tactical Adaptive Strategies Update

Performance

Two of our three strategies managed to hold onto gains in spite of the late month decline.

Adaptive Global finished with a gain of 4.2% in February and 4.39% Year To Date. Once again, it was our position in commodities which led the four funds to a strong gain for the month.

Adaptive Income finished with a gain of 2.5% for February and 2.95% YTD. Adaptive Income was invested entirely in high yield.

Adaptive Innovation finished with a loss of 1.0% % for February and gain of 7.1% YTD. A double digit gain evaporated in the face of sharp sell-offs in our two ARK Innovation funds. The Treasuries used to manage volatility significantly ameliorated the loss.

Perspective

Adaptive Income has an exceptionally low Ulcer Index of 0.8% coupled with an extremely high Up/Down ratio of 586%. The Ulcer Index indicates that Adaptive Income drawdowns are not only minimal but the length of drawdowns is exceptionally short. The Up/Down ratio shows that the strategy has gained $5.86 for every $1.00 in loss.

What does this mean to subscribers? It suggests that subscribers who are deeply concerned with the historically high valuations in equity markets are likely to benefit by shifting portfolio allocations in favor of Adaptive Income.

And shifting gears to Adaptive Innovation ... 

I would be remiss if I did not revisit concerns expressed a few months ago regarding the ARK innovation funds which we use in our Adaptive Innovation strategy. Cathy Woods has done a fabulous job in nurturing the ARK funds from idea to success. I have great admiration for the job she has done; however I am concerned that she has become the victim of her own success.

Success never goes unnoticed on Wall Street and investors have driven fund assets from $10B a year ago to $60B. The ARK Funds are now consistently among the top recipients of investment dollars among all ETFs.  ETFs can not be closed to new investors so as money flows in they are forced to continue buying stocks no matter the quality. 

The ARK funds “innovation” mandate is a market niche in which there are a limited number of quality companies in which to invest. Investment flows into the ARK funds are now so large that their purchases are driving selected stock prices upward which propels the fund prices higher which begets even more fund purchases which begets higher stock prices. An increasing share of ARK funds are invested in companies where they own 10%+ of the float.

This is a virtuous circle until it isn’t. The day will come when the entire process shifts into reverse.

While we are appreciative of the steady gains from Tactical Innovation; subscribers should not lose sight of the fact that risks are becoming elevated. The fact that the Tactical Model has capped volatility by increasing its allocation to Treasuries is a warning.

We (personally) will continue to hold our modest allocation to Tactical Innovation with the expectation that the Tactical Model will continue to balance risk and reward. Subscribers with larger allocations to Tactical Innovation should take note of our concerns.

Ivy Fund Distribution

The Ivy Fund finally reported its February distribution on Saturday morning. The distribution of 0.0371 is equivalent to a simple annualized yield of 6.2%.

Market

From the February 26th Market Monitor

"All equity indexes declined last week with the mid and small cap indexes dropping the least. The drop in the banking index was also small reflecting the benefit to banks of higher rates. While last week’s decline is reflected in bullish but oversold in the daily indexes, the weekly indexes remain bullish with bearish divergences. This is a condition which generally brings a short term rally followed by a continued correction.

The S&P 500 is sitting on a weekly trendline drawn from the March 27 low while the S&P 1500 is sitting 2%+- above its trendline from the March low. The latest bull market remains intact as long as this trendline holds.

Cumulative Advancing Declining Volume improved on the week which suggests that the market is not yet seeing meaningful distribution during the correction.

The Credit Market Index remained unchanged this week. Most notable is that while we are seeing increases in yields on Treasury and investment grade bonds, yields on junk and emerging market bonds remain unaffected.

The 10 Year Treasury yield closed at 1.46%, one tick off my 1.47% target. The yield, which peaked at 1.61% on Thursday, is unlikely to move higher without a period of consolidation.

The most concerning aspect of last week’s market action occurred in the longer end of the Treasury market which incurred its third weak auction: 30 year bond auction on Feb 11, 20 year bond auction on Feb 17, and the 7 year note auction on February 25. We are seeing signs that the Treasury is facing difficulty in placing new debt and rolling over existing debt. 

The market remains in a relentlessly expanding bubble which now exceeds all previous bubbles by virtually every possible metric. The trend appears to be unstoppable but it is not, we just don’t know the when and where.  The rise in Treasury yields appears to be putting pressure on equities (along with gold); however the positive trend in the Credit Market Index suggests that the stress has yet to open serious cracks in the equity and credit markets."

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 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.