Tactical Asset Allocation – July 2020

Tactical Adaptive Strategies Update

Performance

Adaptive Global gained 2.74% for the month and has gained 1.68% YTD. Adaptive Global spent the month invested in a broad range of Treasuries from 3 to 20 years and precious metals.

Adaptive Income gained 1.82% for the month and 5.42% YTD. Adaptive Income’s investment remained split between corporate bonds and high yield.

Adaptive Innovation gained 2.28% for the month and gained 10.31% YTD. Adaptive Innovation split investments between intermediate and long term Treasuries.

Perspective

Second quarter Gross Domestic Product (GDP) was released on Friday. Ignoring the headline 32%+ annualized decline, the actual 9.98% decline from $21,561.1 billion to $19,408.8 billion is not so dramatic. However, the Buffet Ratio of Market Capitalization divided by GDP reached its highest level on record at 172%.

What do we see if we take a step back for a look at the market?

  • Equity valuation as measured by MC/GDP is an all time high
  • The S&P 500 Index ended July at a new all time monthly closing high
  • Treasury yields reached all time lows in July (bond prices at all time highs) and the Merrill Option Volatility Estimate for bonds is at an all time low
  • Gold achieved a new all time high in July
  • Spreads between Treasuries and Junk Bonds are crumbling toward historical lows
  • The US Dollar has fallen to, and threatens to break, a long term trendline back to 2011

I think each of these bullet points can be traced directly to the actions of the Fed. Consider that the Fed’s support of investment grade and junk bond yields has not only removed risk from the bond market, but has removed much of the risk in equity markets. In short, the Fed is the Market.

Will the Fed lose control of the Market? Eventually, yes, but it is unlikely to lose control in the near term.

Economies thrive on confidence and confidence is waning; in large measure due to the major virus flare ups across the country. The euphoria in the equity market is quite likely at or near an end. We are now likely to see many months, perhaps a year, of hard slogging. The “Fed put” may well hold the lows in place but the market is quite likely to cycle sideways in a 1000+- point S&P 500 range for the foreseeable future.

The Role Of TAA In A Portfolio

The FAANGs (et al) and Robinhood Traders have garnered the lion's share of media attention and gains for the past several months. However, indexes which do not include the scrabble letter stocks (including S&P 500 - ex) are all down for the year. They also had mammoth drawdowns in March!

TAA strategies are not designed to chase a handful of story stocks riding a speculative blow-out. TAA strategies are designed to achieve high returns with low risk across a full market cycle.

Links to performance charts and monthly performance tables for each of our strategies (along with the S&P 500 and Vanguard Balanced Index Fund) appear at the foot of each blog post. A quick comparison for the past two full market cycles shows the following:

  • Adaptive Global: 14.5% CAGR with Maximum Monthly Drawdown of 7.7% (20+ years)
  • Adaptive Income: 9.9% CAGR with Maximum Monthly Drawdown of 3.9% (20+ years)
  • Adaptive Innovation: 26.1% CAGR with Maximum Monthly Drawdown of 12.2% (5+ years)
  • S&P 500: 5.9% CAGR with Maximum Monthly Drawdown of 50.8%

The two and a half years since the beginning of 2018 have seen a considerable increase in speculation, valuations, and volatility. While 2 of our 3 strategies have lagged the CAGR of the S&P 500, they have demonstrated much greater reductions in drawdowns:

  • Adaptive Global: 5.4% CAGR with Maximum Monthly Drawdown of 3.3%
  • Adaptive Income: 6.2% CAGR with Maximum Monthly Drawdown of 1.5%
  • Adaptive Innovation: 15.0% CAGR with Maximum Monthly Drawdown of 12.2%
  • S&P 500: 10.2% CAGR with Maximum Monthly Drawdown of 19.4%

The three strategies provide subscribers with the ability to target a combination of return and volatility which is both suitable and comfortable.

Market

From the July 31st Market Monitor

“The major indexes were up close to 2% this week outpaced by the NASDAQ 100 at 4.0% and trailed by the Broker Dealer and Banking Indexes which declined. Trends are becoming mixed as the indexes have mostly moved sideways for the past several weeks evidencing a loss of momentum.

This week showed significant deterioration in Cumulative Advancing Declining Volume. In fact, the negative divergences are significant enough to favor a decline.

The Credit Market Index is unchanged for the week and remains quite positive. Absent deterioration in the Credit Market Index, we are unlikely to see a steep decline in the indexes.

The 10 Year Treasury reached a new record low yield of 0.54% eclipsing the weekly closing low in March. Treasury investors are seeing negative real yields while benefiting from higher bond prices. The Fed has stated it will not allow rates to go negative (which would force levered banks to sell Treasuries) so there is not a lot more room for appreciation.

The trend in precious metals is bullish but extremely extended and due for a correction.

The volatility indexes are not anticipating a decline with declining volatility leading both the S&P 500 and Ru 2000 higher.

Market Cap divided by GDP reached an all time historical high of 172% this week. While the sharp decline in GDP was the proximate cause of the sharp rise, the ratio was already sitting in the 150’s which have capped all rallies.

While indexes could spike a bit higher, it looks like a modest pullback is in the cards.

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)