Tactical Asset Allocation – March 2021

Tactical Adaptive Strategies Update

Performance

Two of our three strategies delivered gains for March.

Adaptive Global finished with a gain of 1.3% for the month and 5.8% Year To Date. The gain was led by positions in the S&P 500 ex-growth and Asia Pacific equities. Commodities which have been dominating returns, took a rest.

Adaptive Income finished with a gain of 0.7% for the month and 4.1% YTD. Adaptive Income was invested entirely in high yield.

Adaptive Innovation finished with a loss of 4.7% for the month and gain of 2.1% YTD. Our ARK funds incurred losses for the month which were significantly ameliorated by the Treasuries used to manage volatility. As discussed in last month’s update, I continue to consider the ARK funds a worthwhile investment for a small portfolio allocation.

Perspectives

The financial news has been full of details on how overvalued the equity market has been for several years now. The number of quantitative and qualitative measures which are at extremes has only grown longer and deeper as the equity market has moved higher.

Valuation measures are irrelevant as tools for timing the market. However valuation measures are a good roadmap for relative risk in owning equities.

This weekend I pulled up a monthly chart of the S&P 500 back to the start of this secular bull market in 1982. I drew a regression line from the beginning and then drew a 4 standard deviation channel around the regression. The S&P 500 is 300 points above the top of that channel. Next, I drew a (steeper) regression line from the 2008 low and then drew a 4 standard deviation channel around the regression. The S&P 500 is 100 points above the top of that channel.

Regressions are useful because they give us probabilities, in this case for the longer channel:

  • 1 standard deviations: 68% of occurrences will fall inside 2750
  • 2 standard deviations: 95% of occurrences will fall inside 3000
  • 3 standard deviations: 99.7%  of occurrences will fall inside 3300
  • 4 standard deviations: 99.9% of occurrences will fall inside 3650

So what does this have to do with Tactical Asset Allocation? After all, TAA strategies are designed to lower investment risk by discarding positions which are performing poorly. And the month by month tables shows that each of the strategies has done a remarkable job in managing investment risk.

That said, each of our strategies has a significantly different risk and reward profile.

  • Adaptive Global 14.9% CAGR versus 7.7% max monthly drawdown
  • Adaptive Income 9.9% CAGR versus 3.9% max monthly drawdown
  • Adaptive Innovation 29.3% CAGR versus 12.2% max monthly drawdown

This provides an opportunity to use our TAA strategy allocations to adjust our portfolios to extremes in valuations.

Market

From the April 2nd Market Monitor

"The major indexes continued to move higher this week led by the NASDAQ 100 and Housing Index. As suggested last week, it appears that having run the mid and small cap stocks higher, the markets are once again rotating toward big cap and tech. The short term S&P 500 target at 4012 was exceeded on Friday and our primary target at 4136 appears to be well within grasp. For conversation purposes, there exists an Extreme Blow-off Target at 4531 … color me “dubious” but nothing should be considered impossible.

Our Speculation Index is taking a rest. It remains to be seen if this is simply another market rotation or investor risk appetites are becoming sated.

Equity market valuation has risen to yet another record high at 197% of GDP. Needless to say, all valuation measures are stretched beyond belief. The reversion, when it occurs, is likely to exceed all modern historical precedent. Markets run on investor psychology and the reversion will not occur until there is a major shift.

The Credit Markets Index remains slightly negative although it improved a bit this week. While rising rates have been exerting negative pressure on the Index; spreads to Treasuries have remained flat. This week’s improvement in the Index was due entirely to a resumption in the decline of high yield spreads which are at historically low and extreme levels.

The yield on the 10 year Treasury retreated a few more basis points this week following a meteoric 0.75% rise. The rise in yields appears to be consolidating ahead of a move higher; quite likely 2%+ with possible targets up to 2.75%.

I am in the camp which believes that the Fed will be forced to take action to cap rates on longer maturities if the 10 year Treasury moves much north of 2%. Actions could include: twisting the yield curve (buy long maturities, sell short maturities), QE (increase purchases of longer maturities), or Yield Curve Control (announcing yield caps and purchasing all of the supply which is not met by demand).

My general sense from all of the data is that the market is running out of room to rally on many fronts: valuation, momentum, and interest rates. This is not the same as turning into a bear market as there are few signs of the material reversal in investor psychology which would presage a major decline."

A Personal Note

As men get on in years, our bodies tend to shrink a bit … with the exception of our prostates. Mine has been no exception. My urologist put me on Tamsulosin years ago and more recently added Dutasteride, the latter a drug which quickly showed some nasty side effects. He also informed me that my prostate had grown too large for anything by invasive surgery.

I am a first class researcher so I began reading published research and clinical reports on possible alternatives. The HoLEP procedure quickly stood out for being minimally invasive, extremely low-risk, and producing superb results with prostates of all sizes.

I traveled to Tucson AZ in mid-April ago to have the HoLEP performed by Dr Joel Funk, one of the country’s leading HoLEP surgeons. The speed of recovery and results have been nothing short of amazing and it gave me great pleasure to throw both the drugs in the trash.

With Spring in the air, vaccines in plentiful supply, and Easter at hand; I want to wish the very best to all of my subscribers and followers.

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.