Tactical Asset Allocation – January 2023

Tactical Adaptive Strategies Update


Adaptive Global finished the month with a gain of 4.03%.  Adaptive Global is our most broadly diversified “go anywhere” strategy with a 22+ year CAGR of 14.4%, a modest maximum drawdown of 7.7%, and a low 9.3% standard deviation of monthly returns.

Adaptive Income finished the month with a gain of 1.89%y. With a 22+ year CAGR of 9.2%, this strategy captures $5 dollars of gain for every $1 in loss. Adaptive Income sports our lowest maximum drawdown of 4.0% and our lowest volatility with a standard deviation of just 4.3%.

The S&P 500 finished with a gain of 6.29% for the month. It has a 22+ year CAGR of 6.4%, maximum drawdown of 50.8%, and standard deviation of 15.5%.

The Vanguard Total Bond Market Index Fund (entirely investment grade) finished the month with a gain of 2.95%. It has a 22+ year CAGR of 3.9%, maximum drawdown of 17.8%, and standard deviation of 4.0%.

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

Subscribers: corrected date for next Rebalance Letter

The next Rebalance Letter will be sent on February 26 for rebalancing on February 28


A Few Words Of Caution

Both equity and bond markets are pricing in lower inflation, a tapering of Fed rate increases, and a soft landing. We will learn in the fullness of time whether the markets are right or wrong. However there is a significant danger lurking even if the Fed stops at just 5% and the economy has a “soft landing”.

An economy feeding on the teat of cheap credit can not suddenly adapt to high cost credit without defaults, bankruptcies, and lower earnings. It's not an all at once process but more like a receding tide which slowly reveals the detritus on the sand.

All loans have an end date at which they must be repaid or renewed. As yields rise, the value of assets which can be sold to repay loans falls.

Loans which are renewed, do so at current (higher) rates. Average yields on Investment grade bonds have risen from 2% to 5%. Average yields on High Yield grade bonds have risen from 4% to 8%. Average yields on junk bonds (CCC and below) have risen from 7-½% to 14%.

Even the Federal Government faces significantly higher interest costs as 30% of the Federal debt comes due during 2023 and must be refinanced at rates which have doubled.

Some loans can not be renewed because the earnings won't fund the higher interest costs. Companies which borrowed heavily at cheap rates to buy back stock now find themselves with unexpected interest costs. Speculative borrowing which penciled out at half the current rates may no longer pay its way.

Finally, lenders are generous with credit and terms when times are good but become far more conservative when the defaults start hitting the books. Bank loan standards have shifted from -30% (loosening) to +40% (tightening) while banks reporting increased willingness to make consumer loans has dropped from +25% (loosening) to -7% (tightening). (Both datasets last reported on November 7)

There is a stealth reckoning coming our way.

What Do Our Models See?

The Market Conditions Model sees improving equity momentum, extended valuations, and improving credit market risk. Should these trends persist, we could see a return to a Balanced condition in the near future.

Our two tactical strategies encompass a broad mix of 27 funds including domestic and international equities, fixed income across the gamut from Treasuries to junk, domestic and international real estate, commodities, and precious metals.

The Tactical Model calculates TrendScores for both short and intermediate trends for the funds in each of our fund baskets.

Our broadest strategy with 22 funds is Adaptive Global which shows positive TrendScores across all but 2 funds; however the confidence levels on many of those funds is low or moderate indicating a lack of high conviction in the positive trends.

Adaptive Income shows positive TrendScores for 5 of the 6 with relatively high confidence levels.

The Fed slowed its increases from 0.75% to 0.50% in December and is expected to raise 0.25% (possibly 0.50%) in its February meeting next week. The last two times the Fed shifted from aggressive rate increases into a final year of measured increases were 2006 and 2018.

During both years, Adaptive Income made excellent use of its ability to switch among the six funds representing different sub-classes of domestic fixed income. For 2006, Adaptive Income shows a return of 8.4% with a Maximum Monthly Drawdown of 0.1% and an astounding Up/Down Ratio (gains / losses) of 14194%. 2018 shows a return of 6.6% with a MMD of 0.8% and an extremely high Up/Down Ratio of 655%.

I want to emphasize here that the market will do whatever it wants to do and that there are no guarantees. That said, the risk reward setup here looks somewhat stronger for Adaptive Income than Adaptive Global which is reflected by Adaptive Global’s inclusion of an allocation to cash.

TAAStrategies Website

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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 January 27th Market Monitor

All major indexes advanced this week led by the Banking Index and NASDAQ 100. No indexes lagged with the minimum gain of 2.1% from the S&P small cap index. All indexes are uniformly neutral and overbought in the intermediate term. Most indexes are neutral and showing bearish divergences in the short term; however midcaps, banking and housing are showing bullish short term trends also with bearish divergences. The combination of overbought intermediate trend and bearish divergences in the short term trend is a setup for a pullback which could be severe, perhaps into a trading range.

Price targets across the indexes are either pointing up or close to reversing from down to up. Nothing has changed from what I wrote last week: “We have a number of indices which are approaching their December pivot highs and appear poised to break higher. While the downside targets at 3390 and 2999 remain in place, they are currently looking less technically probable. I have a nearterm upside target at 4191 and the possibility of an upside breakout above the December high of 4325 is increasing (see below). An upside breakout would definitively put an end to the bear market which began in 2022.

Cumulative Advancing Declining Volume is giving us some bullish trend confirmations among indexes and cyclical sectors.

The Credit Market Index improved once again this week to +47%. Again, repeating what I wrote last week: “The only rates not falling are the Fed’s. The Credit Market is clearly calling a bluff on the Fed Chair! The current improvement in credit conditions is very supportive of a rally in both equities and fixed income. The risk is that the Fed does not fold.

Credit market yields and spreads are consistent with a Fed which is cutting rates!

The 10 year Treasury has completed a possible double bottom at 3.48% with this week’s rise of 3 basis points. The 10 year Treasury market is clearly at a fulcrum waiting for the Fed. Amazingly, the Commitment Of Traders shows Treasury 10 and 30 year bond futures at extremely bullish levels in spite of the recent sharp rise in prices.

Across other metrics:

  • The ValueLine Weekly Model remains on a Buy signal
  • One VIX Model is bullish while the VIX Momentum Model is not confirming the rally
  • Interest has shifted strongly from consumer staples to discretionary (risk on)
  • The growth/value ratio is flattening but growth has yet to get a firm bid (risk off)
  • The Speculation Index is rising (risk on)
  • 4 of 7 former big tech market leaders are showing accumulation (risk on) (AAPL is not)
  • Inflation expectations bounced upward this week from a double bottom (risk off)
  • The 10 year/3 month Treasury spread has declined to a 20+ year record low of -1.03% indicating severe risk of recession

Repeating comments from two weeks ago: “Overall, the message from both equity and credit markets has turned modestly bullish putting the 2022 bear market at risk of ending with a move above 4325 in the S&P 500. This presents investors with an old conundrum: believe the market or believe the Fed.”

Rendering a strictly personal opinion here based on the feel of the markets and doing the Weekly Market Analysis for nearly 40 years; I suspect the bears are going to be disappointed by a move above 4325 and both bulls and bears will be frustrated by many months of sideways chop between the 2021 high and the 2022 low.

The major takeaway this week should be that the market is acting and trending bullish but the market is not prepared for a firm Fed.  A firm Fed could easily remove 300-400 points from the S&P 500. Directional risks are quite skewed to the tails.

Thank you for reading.

Earl Adamy

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