Tactical Asset Allocation – October 2021

Tactical Adaptive Strategies Update

Performance

Adaptive Global finished with a gain of 1.95% for the month and gain of 18.00% YTD. The strategy spent the month invested in domestic big caps, commodities, Investment Grade corporates, and Treasuries. Adaptive Global is our most broadly diversified “go anywhere” strategy with a 20+ year CAGR of 15.1%, a very modest maximum monthly drawdown of 7.7%, and a low 9.4% standard deviation of monthly returns.

Adaptive Income finished with a gain of 0.12% for the month and a gain of 8.16% YTD. Adaptive Income was invested entirely in senior loans. With a 20+ year CAGR of 9.9%, this strategy captures $6+ dollars of gain for every $1 in loss. It is our lowest volatility strategy with a monthly standard deviation of just 4.3%.

Adaptive Innovation finished with a gain of 11.39% for the month and 0.54% YTD. This was our first niche strategy intended to be used for a very small portion of a diversified portfolio. It sports a 6 year CAGR of 24.3%, maximum monthly drawdown of 16.6%, and standard deviation of 16.9%.

Adaptive PM & BTC (Precious Metals and Bitcoin) finished with a loss of 0.34% and gain of 2.39% YTD. This is our second niche strategy. With a standard deviation of 68.3%, this is our most volatile strategy; however the six year CAGR has been 62.9% with a 13.1% maximum monthly drawdown.

See the strategy descriptions, charts, and tables on the Strategies page.

Perspective

Subscribers may have wondered if I still had all my marbles after watching me stick with the 5% allocation to Adaptive Innovation in spite of a bad run of monthly losses this year. Adaptive Income redeemed itself in October.

I raised the caution flag for subscribers in December 2020 and again in February of this year when I wrote:

“The ARK funds “innovation” mandate is a market niche in which there are a limited number of quality companies in which to invest. Investment flows into the ARK funds are now so large that their purchases are driving selected stock prices upward which propels the fund prices higher which begets even more fund purchases which begets higher stock prices. An increasing share of ARK funds are invested in companies where they own 10%+ of the float.

This is a virtuous circle until it isn’t. The day will come when the entire process shifts into reverse.”

That is exactly what happened. The ARK Innovation Fund incurred a 39% loss from its 2021 high to 2021 low as much of the froth was wrung out of the fund. While the Adaptive Innovation strategy has missed a good portion of the loss, it has incurred the largest annual Maximum Monthly Drawdown in its six years of history.

Sticking with the investment plan

Our investment strategy takes a long term view. As I wrote back in May,  “I continue to believe strongly in our Adaptive Innovation strategy; not as a primary investment but as a portfolio niche which provides exposure to the fastest growing segments of our economy. I also believe that Cathy Wood and the ARK Funds will continue to successfully seek out companies which are our future.”

I believe that sticking  with a carefully considered investment strategy is incredibly important to long term investment success. In this case, we have stuck with an investment in innovation which has a sound long term track record.

Allocation sized to match our risk tolerance

Back in May I once again wrote about the ARK Funds and the Adaptive Innovation strategy: “I continue to believe strongly in our Adaptive Innovation strategy; not as a primary investment but as a portfolio niche which provides exposure to the fastest growing segments of our economy.”

Our allocations to the Adaptive strategies are based on our risk tolerance which in this highly valued market  leans toward the conservative. Our largest allocation is to Adaptive Income which comes with an Ulcer Index of just 0.7%, Standard Deviation of Monthly Returns of 4.3%, and Maximum Monthly Drawdown of 3.9%. Our second largest allocation is to Adaptive Global with an Ulcer Index of 2.1%, Standard Deviation of 9.4%, and Maximum Monthly Drawdown of 7.7%.

Adaptive Innovation carries an Ulcer Index of 4.7%, Standard Deviation of 16.5% and Maximum Monthly Drawdown of 16.6%. The small allocation of just 5% makes the higher volatility tolerable in view of the high historical Compound Annual Growth Rate of 24%.

Confidence in Tactical Asset Allocation methodology

The very reason for using Tactical Asset Allocation is to employ a proven and non-discretionary methodology for investment which does not require close supervision and frequent adjustment.

I have been using Tactical Asset Allocation since 2012 and began developing my own Tactical Asset Allocation strategies in 2014. I have a very high level of confidence in the methodology and algorithms. While each of the strategies is subject to an unwanted string of monthly losses, the statistical probabilities upon which the risk management algorithms are based favor a return to up trend or exit to cash.

One rule I have followed religiously from day one has been to stick with the fund allocations.There have been many times when I questioned the wisdom of fund selections for the following month only to be gratified that I stuck with the system.

From the October 29nd Market Monitor

The major indexes were mixed with the mega cap S&P 100 and NASDAQ 100 leading while the Banking and Broker Dealer indexes declined sharply. Intermediate term momentum readings on the big cap indexes are bullish and overbought while the short term readings are weakening.

Cumulative Advancing Declining Volume weakened again this week. All 5 S&P indexes are showing bearish divergences to price and 10 of 12 sectors are showing bearish divergences to price with only Energy and Finance remaining bullish. The deterioration appears to be reaching a tipping point.

The Credit Markets Index remains quite negative at -53%. Corporate yields are rising globally across the US, Europe and Emerging Markets. Yield spreads are rising in Europe and Emerging Markets but remain relatively flat domestically. Rising Euro and EM yield spreads are unlikely to continue without affecting US markets. The dip in the 10 year Treasury appears to be corrective following a sharp rise.

Updating the current watch list :

• The Speculation Index, which has been rising, turned sharply downward this week
• The Russell 2000 and Midcap S&P 600 have been trading in a tight sideways range since March and May respectively. The Midcap index broke out last week; however the Smallcap, which appeared poised for breakout, appears to be losing momentum.
• The big three mega cap leaders AAPL, MSFT, and GOOGL remain strong, the next four are mixed.
• Growth received a big boost this week as investors shifted away from value
• Consumer Discretionary remains better bid than Staples which is risk on
• Inflation expectations inexplicably dropped this week
• Breadth narrowed this week as attention shifted to the mega caps
• The S&P 500 shows 7 Distribution Days in the past 30 trading days (0.2% decline on higher volume), and 1 Accumulation Day last week for a total of 1 in the past 30 trading days (1% rally on higher volume)
• The ValueLine Weekly Model moved to a Buy last week
• The VIX levels and signals remain constructive.

The broad equity market is growing decidedly weaker even as the megacap indexes move to new highs.  While not unsustainable in the short term, it is a condition which can not persist in the long term. With scores of valuation measures at historical highs, downside risks are elevated.

Thank you for reading.

Earl Adamy