Tactical Asset Allocation – May 2020

Tactical Adaptive Strategies Update

Performance

Adaptive Global gained 0.69% for the month and has lost 4.52% YTD. Adaptive Global turned in a modest gain on a mix of investment grade bonds and precious metals.

Adaptive Income gained 0.59% for the month and 2.70% YTD. Adaptive Income turned in a modest gain on investment grade bonds.

Adaptive Innovation lost 0.51% for the month and gained 2.32% YTD. Adaptive Innovation gave up ground on long term Treasuries

SPY (S&P 500 ETF) gained 4.76% for the month and lost 4.87% YTD

Perspective

The economy has to be reopened! Just as there are potentially dire consequences from the virus, there are dire consequences from shuttering the economy. By all appearances, there has been a failure in balancing and prioritizing the consequences; however investing is the business of looking forward.

The economy is now reopening and the enthusiasm is palpable even though it will likely turn out to be somewhat misplaced. There is no effective treatment, no vaccine, tens of thousands of businesses will remain shuttered forever, tens of millions remain unemployed, and the bankruptcies are just getting started.

These are all issues and challenges which will be met, but it will require months and years, not days and weeks. We are just 47 trading days beyond the March 23rd low and the S&P 500 has already recovered 73% of its decline. That might not be so extraordinary were it not for the fact that at its high, the Market Cap to GDP (aka Buffet Ratio) stood at a nosebleed 159%. Given the current level of damage to GDP, the Ratio is quite likely pushing close to 200%.

Patience should provide us with improved entry points for taking on risk.

Global Adaptive update

In March’s letter, I mentioned that I would be reviewing the use of the Emerging Markets ETF under Balanced Market conditions and in April’s letter I reported that I would be extending the evaluation of risk/reward contribution to all 24 of our ETFs under each of our three market conditions: Favorable, Balanced, and Hostile. I also announced that the “review will be completed and changes implemented before the rebalance at the end of May”.

I made a concerted effort some months ago to extend our backtesting from 2007 back to 2000 by identifying ETF predecessor Open End Funds (OEFs) for which the indexing and/or subclass is substantially similar to the ETFs we are using. This has provided a second full market cycle across which to evaluate risk/reward contributions for our Adaptive Global ETFs. The fact that the metrics of both cycles are very comparable appears to validate the process.

The Up/Down Ratio for each strategy measures the dollars returned for each dollar of risk. My minimum target when developing strategies is $2 of return for each $1 of risk expressed as an Up/Down Ratio of 200%. We had a few ETFs which were performing well for the full strategy but significantly underperforming under one market condition. I was able to improve ETF performance under each market condition and overall by shifting a few ETFs in/out of the market condition baskets.

The upgrade improved the Up/Down Ratio for each market condition as well as raising the overall Up/Down Ratio from 211% to 243% for the period January 2000 through April 2020. It also improved upon the consistency of annual returns. Here is how the upgrade and original compare:

  • Up/Down Ratio 243% versus 211%
  • Compound Annual Growth Rate 14.5% versus 13.9%
  • Ulcer Index (drawdown depth/duration - lower is better) 3.5% versus 3.9%
  • StDev Monthly Returns (lower is better) 9.3% versus 9.4%
  • Maximum Monthly Drawdown 7.7% versus 7.6%
  • Maximum Daily Drawdown 15.1% versus 15.6%

The “Tactical Adaptive Global Chart and Table” at the foot of this blog includes tables for both the original and updated strategies.

We are using the upgraded Adaptive Global for the June allocations.

The May update will include performance tables for both the original and upgraded Adaptive Global strategy.

Market

From the May 29th Market Monitor

“Indexes were up again this week led by small and mid caps as well as the Broker Dealer, Bank, and Housing indexes. All of the major indexes have reached short term overbought levels.

Cumulative Advancing Declining Volume maintains a strong bearish divergence to price in the mega and big cap indexes and more modest bearish divergences to price in the mid and small cap indexes. This is particularly noticeable for the most recent leg of this rally which began two weeks ago.

The credit market index has improved to a positive 35%. The Fed is now the credit market and now effectively controls the Treasury, investment grade, and high yield markets through yield control and direct purchases in the corporate market and ETFs. That said, the credit market remains bifurcated according to quality as evidenced by poor performance of CCC rated debt which is where we are seeing the headline defaults and bankruptcies.

The ValueLine and VIX Models remain on buy signals.

My general sense is that the market has reached an important inflection point. On one hand, the Fed’s balance sheet expansion has been supportive of equity prices; however the Fed has recently reduced balance sheet expansion to relatively low levels. On the other hand, market internals are deteriorating. The combination suggests hedging risk rather than aggressive directional bets long or short.”

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)