Tactical Asset Allocation Strategy Update
Global Core was flat for June and down 1.47% for the year to date. The Tactical Model moved positions from 75% cash to 100% cash for the month of June.
A "Correction" is an equity market decline greater than 10% and less than 20%; in short, a significant interruption of a Bull or Bear market trend. Tactical Asset Allocation models are very effective in identifying Bull trends and Bear trends but they are challenged during Corrections when there is no trend. This tends to produce a series of frustratingly small gains and losses until the original trend resumes or a new trend begins.
In the 129 months beginning with the Bear Market top in September 2007, Global Core has previously gone entirely to cash 3 times: once for 2 months, and twice for 1 month. Each of the prior three cases marked an important inflection point in the equity markets.
Why Did We Go To Cash In June?
The hallmark of the Global Core Strategy is risk management based on Targeted Volatility which is a 6%-8% annualized Standard Deviation for the portfolio. (See Standard Deviation Monthly and Daily in the performance tables.) This very low Standard Deviation is what keeps our drawdowns so low and full market cycle returns so high.
The major equity indexes come with volatilities which are well above 6%-8%: the big-cap SPY clocks in at @ 19%, mid-cap MDY @ 22%, and small-cap IWM @ 24%. On the other hand the major fixed income indexes carry much lower volatilities in the 7% to 1% range. We meet our volatility targets by blending equities with fixed income in various ratios and then performing our fund selections based on the net volatility. Finally, we rate each potential selection on the basis of its Intermediate Term momentum. Every one of our Trend Scores was negative at the end of May.
Two words: "secondary high", sums up my current equity market outlook. By secondary high, I refer to a high which may be lower or nominally higher than a previous high but one which completes an important market top. A secondary high is also accompanied by lower momentum and lower quality market breadth.
While investors have remained relatively loyal to equities, the markets are seeing headwinds which were not so apparent last January. Fresh headwinds include:
- interest rate increases which are beginning to bite (and more to come) with concurrent reduction in Fed holdings
- higher consumer and producer price indexes (there is already some evidence of producers using the tariff excuse to hike prices opportunistically)
- growing Federal deficit which requires increased funding
- turmoil in trade relationships and international supply chains
- reduced earnings following the on-off effects of tax cuts
Credit spreads are also rising. The fact that the majority of High Yield debt (bonds and bank loans) is being issued (and reissued) under "Covenant Lite" conditions tells us that the default rate will eventually soar far above historical averages. Overall, the tightening trend signals the very early stages of credit contraction. Notably, "CCC and Below" rated credit, the junkiest of the junk, which had seen sharply falling spreads and yields into mid-June, are now experiencing sharp increases in both yields and spreads.
My general outlook is that Treasury rates will rise gradually until the markets blink. We'll know that the markets are blinking because the credit spreads will tell us. The Fed will blink afterward. A crash will see a flight to safety in Treasuries (lower yields again) while corporate and high yield go their own ways. Once the markets stabilize, Treasury rates are going to start rising again as debt, currency, and inflation issues take center stage.
Tactical Model Upgrade
I now have a half dozen variations of Dynamically Adaptive Momentum working with the preliminary basket of funds. While early results look promising, there is considerable work ahead to identify potential weaknesses and build upon strengths. My objective is to have an investable strategy ready for use late this summer or early fall.
To recap the objectives for the new TAA Strategy:
I have completed work on a preliminary basket of funds which emphasizes both domestic and international diversification across equities, fixed income, and commodities. This will provide the Model with maximum opportunity to adapt to future market conditions even if they are unlike anything in recent history. (I expect future conditions to be far more similar to the 1966-1980 period.)
My current efforts are focused on Improving trend identification. A thorough reading of research papers on TAA going back to the 1970's reveals that development of TAA models has been based on using fixed length periods for trend identification. (A simple example would be calculating the change in price over a fixed period of 10 months.) While use of fixed length periods has proven robust over many decades of testing; the period selected is either arbitrary and/or optimized to previous history. I believe that I have developed the technology required to intelligently and dynamically adapt momentum period lengths to current market conditions.
Daily and Weekly Website Updates
The Proforma "Portfolio" page is updated in near real-time with daily and month-to-date performance. I generally get dividends posted within a day or two of x-date. This page now includes the date of the next Rebalance Notice as well as the next Rebalance Date.
The "Market Monitor" page is updated each weekend. It provides an updated assessment on the health of the equity market as well as interest rates, commodities, and precious metals.
Tactical Asset Allocation Strategy Performance
Global Strategy (Conservative)
Year-to-date: 1.47% loss
Full cycle-to-date (Sep 2007): 12.56% CAGR, 6.89% Max Monthly Drawdown
Global Strategy (Aggressive)
Year-to-date: 1.47% loss
Full cycle-to-date (Sep 2007): 15.82% CAGR, 8.21% Max Monthly Drawdown
Tactical Asset Allocation Fund Basket Performance
Year-to-date: 1.47% loss
Full cycle-to-date (Sep 2007): 9.3% CAGR, 7.1% Max Monthly Drawdown
Global Satellite (includes Favorable & Hostile)
Month-to-date: hibernating since Jul 2016
Year-to-date: hibernating since Jul 2016
Full cycle-to-date (Sep 2007): 21.23% CAGR@Risk*, 8.22% Max Monthly Drawdown
*CAGR for the Favorable and Hostile Market Conditions during which Global Satellite was invested