Tactical Asset Allocation – January 2021

Tactical Adaptive Strategies Update

Performance

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

Adaptive Global finished with a gain of 0.19% for January. It was our position in commodities which enabled the strategy to post a gain for the month in spite of a very small loss in Asia Pacific and larger declines in the S&P 500.

Adaptive Income finished with a gain of 0.83% for January. Adaptive Income was invested entirely in high yield.

Adaptive Innovation finished with a gain of 8.23% for January. Investments were split between two ARK Innovation funds and Treasuries used to manage volatility.

 

Equity Market Correction

We have been pointing to the combination of extreme equity market valuation coupled with extreme price excursion and warning of the elevated risk of a sudden and sharp decline. The decline which began on Wednesday appears poised to target a 10% - 12% decline into the 3300-3500 range. We will learn, in the fullness of time, if the subsequent rally can maintain the bullish trend.

For now, the short term bases in both the US Dollar and 10 Year Treasury are supportive of a continuation of the equity correction.

Perspective

The market has turned into a battle between the LittleGuys (Robinhood, WallStreetBets, et al) and an assortment of BigGuys (hedge funds and other major market players). I have no doubt that the BigGuys will win.

Citadel not only helped prop up Marvin Capital (on the wrong end of the GameStop short squeeze launched by the LittleGuys) with $2.5 Billion but buys the order flow from all of the major brokers providing commission free trades. In short, Citadel sees the retail orders before the exchanges do. Hedge funds previously on the sidelines of the Big Short Squeeze are taking advantage of the chaos launched by the LittleGuys

None of this should be happening in capital markets which exist to provide essential investment capital to business.

  • The regulators have turned a blind eye to hedge fund short positions which far exceed the float in the stocks they have shorted.
  • It has long been illegal to launch a coordinated series of transactions for the purpose of influencing the sale price of any listed security.
  • Citadel buys virtually all of the retail order flow which it feeds into its High Frequency Trading systems to front run the retail orders and earn billions with minimal risk.

Then there are the Regulators who, when chaos strikes, come down on the side of law, order, and the BigGuys. In other words, if the battle persists, expect some new rules which “restore order to the markets” and disadvantage the LittleGuy. The BigGuys will not be prevented from continuing their market abuses. Those old enough to remember when the Hunt brothers cornered the entire silver market in 1980, will recall that the regulator and exchanges fixed the problem by simply changing the rules.

So how does this bear on our investments? “Bad” stocks have to be bought to cover short positions and “good” stocks have to be sold to cover the losses and margin calls. All of this gamesmanship increases volatility in a market which is already extremely extended.

The combination of extremely extended markets and high volatility is not an investor’s friend. In fact, rising volatility is indicative of a trend which is beginning to wobble. We incorporate volatility measures into our strategies for this very reason.

Market

From the January 29th Market Monitor

"The major indexes sold off this week. The mid cap, small cap, banking and housing indexes led the decline. The broad equity indexes remain Bullish with bearish divergences on an intermediate term basis and Bullish and oversold on a short term basis. This combination argues for a rally which fails followed by further decline.

The VIX Model (intermediate term) and VIX Daily Model (short term) both moved to a Sell this week. The ValueLine Weekly Model missed a Sell by just 0.15 points. This combination suggests the correction has more time to run.

Cumulative Advancing Declining Volume weakened again this week for both broad indexes and sector indexes. The weakening in CADV generally confirms the weakness in price but so far lacks evidence of major distribution.

The Credit Markets Index declined again this week but remains positive. The decline is attributable to further flattening in both spreads and yields. We have yet to see spreads tick upwards which would signal rising investor risk aversion.

The rise in Treasury yields appears to have stalled for now; however the 10 year Treasury continues to target a move higher to 1.25%-1.47%.

The rise in yields and decline in equities is also reflected in the US dollar which has completed a short term base and appears destined to rise. This is quite likely a short term phenomena which will be reversed within a few months or sooner if the credit markets begin to exhibit signs of trouble. A rising US$ is extremely unlikely to persist in the face of rising deficits and the Treasury’s need to roll very large amounts of maturing debt.

Historically, a Buffet Ratio (Market Cap divided by GDP) in the 135% to 150% range has halted market rallies. The Covid Crisis accompanied by falling GDP and a rising equity market has seen the ratio rise to an extreme 193%. It has since pulled back slightly to a still extreme 183%.

The market correction which began on Wednesday is likely to continue into the 3300-3500 range."

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.