Tactical Adaptive Strategies Update
Adaptive Global spent the month in cash and shows a gain of 0.15% YTD. Adaptive Global is our most broadly diversified “go anywhere” strategy with a 22+ year CAGR of 14.3%, a modest maximum drawdown of 7.7%, and a low 9.3% standard deviation of monthly returns.
Adaptive Income finished with a gain of 0.87% for the month shows a loss of 2.31% YTD. With a 22+ year CAGR of 9.2%, this strategy captures $5 dollars of gain for every $1 in loss. Adaptive Income sports our lowest maximum drawdown of 4.0% and our lowest volatility with a standard deviation of just 4.3%.
Adaptive Innovation has been in cash since March 1 and shows a loss of 2.76% YTD. This is a niche strategy intended to be used for a very small portion of a diversified portfolio. Adaptive Innovation sports a 6 year CAGR of 17.7%, maximum drawdown of 20.3%, and standard deviation of 16.3%.
The S&P 500 finished with a gain of 5.6% for the month and a loss of 13.2% YTD. It has a 22+ year CAGR of 6.5%, maximum drawdown of 50.8%, and standard deviation of 15.4%.
The Vanguard Total Bond Market Index Fund (entirely investment grade) finished with a gain of 3.5% and shows a loss of 12.9% YTD. It has a 22+ year CAGR of 3.8%, maximum drawdown of 17.8%, and standard deviation of 3.9%.
See the strategy descriptions, charts, and tables below or on the Strategies page.
Time To Get Back In The Water!
There are two critical parts of investing: knowing when to reduce risk and knowing when to increase risk. The TAAStrategies bring a disciplined, mechanical process to our investing. This allows us to avoid the emotional attachment to our funds when they appear to be going up and emotional attachment to cash when the funds appear to be going down.
We have credible history for the Adaptive Global and Adaptive Income strategies back to 2000. 2022 is the only year that either strategy has spent a significant part of the year sitting in cash. The cash allocation has been a blessing in light of the 13.2% YTD decline in the S&P 500 and the 12.9% YTD decline in the Vanguard Bond Fund which is limited to investment grade bonds.
We are back in the market although modestly invested.
Bonds have been mauled during 2022 but a look at the history of Adaptive Income suggests prospects may be looking up.
There are strong indications from the Fed that it plans to begin slowing the rate of increase in the Fed Fund rate beginning in December. The last two times the Fed shifted from aggressive rate increases into a final year of measured increases were 2006 and 2018.
During both years, Adaptive Income made excellent use of its ability to switch among the six ETFs representing different sub-classes of domestic fixed income. For 2006, Adaptive Income shows a return of 8.4% with a Maximum Monthly Drawdown of 0.1% and an astounding Up/Down Ratio (gains / losses) of 14194%. 2018 shows a return of 6.6% with a MMD of 0.8% and an extremely high Up/Down Ratio of 655%.
I want to emphasize here that the market will do whatever it wants to do and that there are no guarantees. That said, the risk reward setup here looks reasonably decent while we wait for more clarity from the equity market and Adaptive Global.
Bull Market Ahead?
Many commentators use an arbitrary 20% gain or loss to label bull and bear markets. While a 20% rally from the closing low lies at 4292, a far superior method for labeling bull and bear markets is to use the information provided by the closing price structure on the weekly chart.
Quite simply, a bear market requires a series of lower lows and lower highs while a bull market requires a series of higher highs and higher lows. Given this structure, we easily confirm whether a 20% move in either direction is truly a bull or bear market.
The weekly closing high in the S&P 500 occurred on December 31 at 4766. This was followed by a series of lower lows and lower highs through 3583 on October 14, a 23.4% bear market decline.
Since then the S&P 500 has notched a 13.6% rally consisting of a spikey series of higher highs and higher lows. What would it take to turn this rally into a bull market? The last major pivot high preceding the October low occurred on August 12 at 4280 … 19.5% above the October 14 closing low. Should the S&P 500 exceed 4280 without making a lower low, we should treat it as a bull market even without the full 20%.
Whether a new bull market can exceed the previous all time high is another question.
RIP Adaptive Innovation
I introduced Adaptive Innovation to provide low risk investment access to innovation technologies. It provided significantly higher return for significantly higher risk and was therefore intended for use as a niche allocation in a portfolio.
Tactical Innovation has mitigated risk by remaining in cash for the last 10 months of 2022. However, the Compound Annual Growth Rate (CAGR) for Tactical Innovation has fallen to 17.7% with a Maximum Monthly Drawdown (MMD) of 20.3%. The risk:reward for Tactical Innovation is no longer favorable when compared to the 14.3% CAGR of Adaptive Global with a MMD of 7.7%. I am discontinuing the strategy.
Existing subscribers will have access to Tactical Innovation through the end of 2023.
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 December 2nd Market Monitor
All major indexes were up this week except for Banking. While a few of the indexes are overbought on an intermediate term basis, several including the S&P 500 are still a little short of overbought. On a short term basis, the indexes are one short of unanimous in being overbought with bearish divergences. The combination favors some minor gains followed by a correction to the rally.
Looking to the upside, the S&P 500 target at 4122 remains in play and still appears to be achievable. The line in the sand is a weekly close above the August 12 weekly closing high at 4280 which (in my book) would signal a new bull market even though 0.5% short of a 20% rally. Looking to the downside, the intermediate downside targets remain in place at 3390, and 2999.
Cumulative Advancing Declining Volume remains positive although weakening, especially in the short term time frame.
The short term index breadth models are giving clear non-confirmation to the rally in prices which suggests that the rally is losing some momentum.
The Credit Markets Index improved sharply again this week to a near-neutral -3% reflecting an established decline in credit spreads even as yields remain in a rising (but flattening) trend. The Credit Markets are signaling a significant easing in credit conditions which is risk on for equities. This is likely the most important contributor to the equity rally so I’ll be watching for signs of deterioration.
The 10 year Treasury yield fell to 3.51% this week in a near vertical decline from the high at 4.21%. In looking for some guidance here, I find that short-mid-long Treasury ETFs are beginning to show some accumulation (volume) necessary to confirm the rally in prices. I suspect we are going to get a pullback in prices (rally in yields).
Across other metrics:
- The rally is (so far) unsupported by a critical shift from consumer staples to discretionary (risk off)
- The rally is (so far) unsupported by a critical shift from value to growth (risk off)
- The Speculation Index is rising (risk on)
- 5 of 7 former big tech market leaders continue lagging (risk off)
- The VIX Models are now confirming the rally.
- Inflations expectations remain elevated and rose this week (risk off)
- The 10 year/3 month Treasury spread has issued a recession ahead signal
- The early strength in small caps appears to be weakening
In my view, the equity decline was driven by deteriorating conditions in the credit market. While easing conditions have been supportive of the recent rally in the equity and fixed income markets; credit conditions remain negative. Breadth and volume remain modestly positive although momentum is waning. There is no sign of the shift to growth equities which is critical for a major rally.
Conditions favor another week or so of equity rally followed by a correction into what is generally a seasonally strong period for equities. While it is possible that we could be witnessing the beginning of a new bull market; it is more likely that we will see an extended period of sideways price action until the mix of inflation, GDP growth, and rate hikes shows more clarity.
Thank you for reading.
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