Tactical Asset Allocation – October 2022

Tactical Adaptive Strategies Update

Performance

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 spent the month in cash and shows a loss of 3.16% YTD. With a 22+ year CAGR of 9.2%, this strategy captures nearly $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 17.9%, maximum drawdown of 20.3%, and standard deviation of 16.4%.

The S&P 500 finished with a gain of 8.13% for the month and a loss of 17.75% YTD. It has a 22+ year CAGR of 6.3%, maximum drawdown of 50.8%, and standard deviation of 15.4%.

The Vanguard Total Bond Market Index Fund (entirely investment grade) finished with a loss of 1.60% and shows a loss of 16.01% YTD. It has a 22+ year CAGR of 3.7%, maximum drawdown of 18.0%, and standard deviation of 3.9%.

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

Perspective

The S&P 500 was up for October month because equities were extremely oversold (too far down too fast) and equity market participants were beginning to believe that the Fed was about to pivot thereby saving the economy from considerable pain.

The Fed has turned into something of a Hydra. In times gone by, speaking was generally limited to the Chair. These days, almost every day has speeches listed for several regional Fed presidents each trying to move the needle toward their bias. Several have been tilting dovish and that has provided gas to equities. That was all turned on its head Wednesday when Powell made clear in no uncertain terms that he intends to keep hiking and deal with the damage when it occurs. Two days into November and the S&P 500 is already down 2.9%.

If you value early warning in the equity market, you have to keep your eye on the bond market. Bonds traded down during October in spite of bonds being extremely oversold. Bond traders simply did not believe the dovish narrative. The bond market is undergoing the worst rout since the 1930’s.

What do our models think?

The Market Conditions Model sees declining equity momentum, extended valuations, and significant credit market risk.

The Tactical Model sees negative trends across nearly every asset.

The Tactical Model has done an outstanding job of portfolio risk reduction during this bear market and I am confident it will show us the way when it is time to increase risk exposure into the next bull market.

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 October 28th Market Monitor

All major indexes were up for the week led by small and midcaps along with the three canaries: Broker-Dealer, Banking, and Housing. Index momentum is generally bearish and rising on an intermediate term basis and bearish and overbought on a short term basis. While the downside S&P 500 targets remain in place at 3390 and 2999, the rally targets 4002.

Cumulative Advancing Declining Volume is generally confirming the advance in price with a big catch-up this week.

The Credit Markets Index was slightly improved this week. Repeating an important comment: “While global yields continue to rise sharply across the full spectrum of credit quality, spreads are mixed suggesting that spreads are not fully factoring in the increased default risk from sharply higher yields. There is a substantial degree of risk in the credit markets.

The 10 year Treasury pulled back a bit this week after closing last week on a minor target at 4.21%. While the technicals point to a target at 4.88%; I suspect that the rally in yields is getting long in the tooth and do not expect to see 4.88%.

Across other metrics:

  • Consumer sector preferences shows a strong trend of shifting from Discretionary to Staples (risk off)
  • Investors are shifting back to value (risk off)
  • The Speculation Index is declining sharply (risk off)
  • 6 of 7 previous big tech market leaders continue lagging (risk off)
  • While the VIX models have shifted bearish, the VIX indexes are showing bullish divergences. The VIX indexes have exhibited very unusual behavior during this bear market.
  • Inflation expectations have turned up sharply (risk off)

This week looks like a rerun of last week: “The rally is likely to move higher before exhausting itself.” The major risk to the rally will occur mid-week with the Fed’s post meeting announcement. The market is pricing a rumored pivot although none has been announced.

In my view, the equity decline is being driven by credit market conditions which continue to deteriorate sharply. The downside risks from this deterioration can not be overstated. The counter-risk is that credit conditions deteriorate to the point where the Treasury market loses so much liquidity that the Fed is forced to pivot which would likely launch a huge equity rally. Liquidity in the Treasury market improved a bit this week, enough to move it off the edge of the cliff.

Thank you for reading.

Earl Adamy

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Exceptional results are due entirely to the complementary strengths of our Market Conditions Model and our Tactical Model.