Tactical Asset Allocation – June 2023

Tactical Adaptive Strategies Update

Performance

Strategy: Adaptive Global finished the month with a gain of 1.62% and a YTD gain of 3.89%.  Adaptive Global is our most broadly diversified “go anywhere” strategy with a 22+ year CAGR of 14.2%, a very modest maximum monthly drawdown of 7.7%, and a low 9.4% standard deviation of monthly returns.

Benchmark: The S&P 500 finished with a gain of 6.48% for the month and a YTD gain of 16.79%. It has a 22+ year CAGR of 6.6%, maximum monthly drawdown of 50.8%, and monthly standard deviation of 15.4%.

Strategy: Adaptive Income finished the month with a gain of 0.46% and shows a YTD gain of 1.06%. With a 22+ year CAGR of 9.1%, this strategy captures $6 dollars of gain for every $1 in loss. Adaptive Income sports our lowest maximum monthly drawdown of 3.9% and our lowest volatility with a monthly standard deviation of just 4.2%.

Benchmark: The iShares Aggregate US Bond Fund  (entirely investment grade) finished the month with a loss of 0.37% and a YTD gain of 2.26%. It has a 22+ year CAGR of 3.8%, maximum monthly drawdown of 17.1%, and monthly standard deviation of 4.2%.

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

Perspective

June

Tactical Global remained fully invested in a mix of domestic and international equities and domestic bonds. Our positions in the S&P 500 and Asia Pacific provided very strong returns while our positions in Treasury and corporate bonds were a drag on performance.

Tactical Income spent June in Treasury Bills which turned out to be an excellent hideout from the turmoil in fixed income.

One can not miss the stellar performance of the S&P 500 during the first half of this year. Our Adaptive Global strategy is lagging … by a lot. Will it catch up during this nascent bull market? I very much doubt it. In fact, Adaptive Global lagged the S&P 500 during the previous (2020-2021) bull market.

Here is the bull market record of Compound Annual Growth Rate (CAGR) beginning in 2000:

  • Oct 2002 - Oct 2007: S&P 500 15.3% versus Global 19.8%
  • Mar 2009 - Dec 2019: S&P 500 16.9% versus Global 15.4%
  • Apr 2000 - Dec 2021: S&P 500 44.0% versus Global 19.7%
  • Oct 2022 - Jun 2023: S&P 500 35.6% versus Global 6.4%

Here is the bear market record of Compound Annual Growth Rate (CAGR) beginning in 2000:

  • Sep 2000 - Sep 2002: S&P 500 -24.8% versus Global +8.6%
  • Nov 2007 - Feb 2009: S&P 500 -41.3% versus Global +6.0%
  • Jan 2020 - Mar 2020: S&P 500 -57.9% versus Global -7.4%
  • Jan 2022 - Sep 2022: S&P 500 -30.6% versus Global +0.9%

Adaptive Global was designed to outperform the market over full bull/bear market cycles while significantly curtailing investor drawdowns. It has met these objectives in every full market cycle beginning in 2000. The numbers speak for themselves: a 14.2% CAGR with a 7.7% Maximum Monthly Drawdown for Adaptive Global versus a 6.8% CAGR with a 50.8% Maximum Monthly Drawdown for the S&P 500.

And Adaptive Income is no slouch either with a 9.1% CAGR and 3.9% Maximum Monthly Drawdown versus a 3.8% CAGR and 17.1% Maximum Monthly Drawdown for the investment grade iShares Core US Bond Fund.

Why are allocations uneven?

The Tactical Model selected four funds for the Adaptive Global strategy in June. The fund allocations ranged from 33.9% to 18.3%. Why not equal allocations of 25% to each fund?

Our Equal Weighting and Volatility Limit algorithms were developed to significantly decrease portfolio volatility. These comparisons demonstrate the tradeoffs in return and risk across 22+ years of history.

Adaptive Global shows a 3.5% decrease in return for a 21% decrease in Maximum Monthly Drawdown and 9.6% decrease in Standard Deviation.

  • Equal weight: 14.7% CAGR - 9.7% Max Mo DD - 10.4% Std Dev
  • Volatility weight w limit: 14.2% CAGR - 7.7% Max Mo DD - 9.4% Std Dev

Adaptive Income shows a 2% increase in return, a 20% decrease in Maximum Monthly Drawdown, and an 11% decrease in Standard Deviation.

  • Equal weight: 9.0% CAGR - 4.9% Max Mo DD - 4.7% Std Dev
  • Volatility weight w limit: 9.2% CAGR - 3.9% Max Mo DD - 4.2% Std Dev

Volatility Weighting algorithms allocate larger percentages to funds with low volatility and smaller percentages to funds with high volatility. The strong advantage of Volatility Weighting becomes clear when one understands the cycle of volatility in all securities. As a general rule, volatility declines in strong trends and rises when trends weaken or change direction. Thus, low volatility provides confidence in the sustainability of a trend while high volatility is a warning that the trend is weakening or about the change.

We can summarize the life of a trend:

  • New trend: volatility rises during the transition in direction from the old trend
  • Established trend:: volatility falls as the trend become established and sustainable
  • Trend ending: volatility rises during the transition in direction to a new trend

The Volatility Limit algorithm steps in when the expected volatility of the strategy allocations exceeds the cap by shifting allocations from higher volatility funds to lower volatility funds until the targeted volatility for the strategy falls within the cap.

What Do Our Models See?

Market Conditions Model: The Market Conditions Model, which oscillated between Hostile and Balance during most of April, settled on Balanced for the rebalance at the end of April. Although the shift from Hostile to Balanced appears to be more reflective of indecision than a firm trend, the Model remains in Balanced condition for the rebalance at the end of June.

Tactical Model: The Tactical Model calculates TrendScores for both short and intermediate trends for all 27 of the funds we use. The current environment is marked by a great deal of uncertainty. 15 funds (up from 12 last month) show positive trends; however only 5 of these rank “high” in confidence for trend persistence. Again, this is most reflective of indecision.

Subscription Change (reminder)

We are shifting from one-time annual subscriptions to recurring quarterly. While this entails some additional effort and costs, we trust that subscribers will find it a bit easier on the wallet. As your annual subscription comes up for renewal, you will receive the usual email reminder with a link to the quarterly subscription renewal. Where necessary, expiration dates are extended to compensate for any overlap in end and begin dates.

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 June 30th Market Monitor

All major indexes rose this week led by the S&P small and mid cap indexes which were up 4.3%. The Housing Index rose to a new all time high. All indexes ex the Bank Index are overbought in the intermediate time frame and bullish and rising in the short term time frame. We got the expected correction last week; however it was abbreviated. We may see the indexes rise another 1%-2% before getting a moderate correction.

Cumulative Advancing Declining Volume is strongly confirming the rally on a short term basis but is significantly lagging the rally on an intermediate term basis. Across the major indexes, CADV is confirming the rally while small and mid caps continue to show bearish divergences. On a sector basis, we have just 6 sectors as bullish, 5 sectors with bearish divergences, and 1 neutral. The concentration remains problematic in a rally this far advanced.

The Credit Markets Index is unchanged this week at a positive 27%. Most notable is the decline in junk (CCC and below) bond spreads. The current loose credit conditions run counter to the Fed’s stated intent to tighten conditions to slow both the economy and inflation. The Credit Markets Index says that the Fed speaks with a forked tongue. Credit conditions are favorable for equities.

The downside target in the 10 year Treasury at 3.20% has held for 3 months. The 10 year Treasury rose 8 basis points this week to 3.82%. I am watching a bull flag on the weekly chart where the yield has now risen to the upper channel line. A higher close next week would signal a continuation of the rally in yields with next resistance at 4.09%. If broken, the 10 year would target the previous high at 4.32% and from there a minimum target of 4.62%. Treasury intermediate and long term ETFs are showing distribution. Probabilities favor a move higher in the 10 year Treasury.

Across other metrics

  • The ValueLine Weekly and Daily models remain on a buy signal
  • Our primary VIX Model continues bullish while the other VIX Model is showing bearish divergences. The unprecedented volumes now trading in one day options does raise questions regarding the reliability of VIX based signals (risk on)
  • The Short Term Breadth Model is negative for both issues and volume (risk off)
  • Consumer Discretionary continues to be preferred over Staples which are being ignored (risk on)
  • The growth/value ratio is favoring growth in both small caps and mega caps (risk on)
  • The Speculation Index is flattening (risk off)
  • 7 of 7 big tech market leaders continue showing accumulation (risk on tech mega caps)
  • Inflation expectations are flattening (risk on)
  • The 10 year/3 month Treasury spread remains well under -1% which is a historically negative level indicating  severe risk of recession. However, given the projection for a higher 10 year, we can not rule out the possibility of atypical behavior where long rates rise in lieu of short rates falling.
  • Treasury ETFs continue to show signs of distribution

The S&P 500 has risen 20% from its weekly closing low which is enough to call it a bull market. Price momentum continues to favor another 1% - 2% upside before we get a significant correction. While breadth has improved markedly, it still when compared to the strong advance in the major big cap indexes. Credit market conditions have improved materially and are no longer a drag; however Treasury yields are showing firmness around their recent highs.

The credit market will bear close scrutiny in coming weeks as it will likely bear first witness to potential weakness in the nascent bull market.

Thank you for reading.

Earl Adamy

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