Tactical Asset Allocation Strategy Update
Global Adaptive was down 0.78% for September and is up 4.86% for the year to date. The Strategy showed a small gain in big cap domestic equities, a large loss in small cap domestic equities, and losses in fixed income.
Comments on last month's allocations
Our new Adaptive Dynamic Momentum algorithms and the new Global Adaptive fund basket provides a good deal of information which was not previously available. The improved "Tactical Models" section of the letter now includes Composite TrendScores and confidence rankings for all major global asset classes. I'm going to begin including some brief commentary on what I believe the TrendScores and confidence rankings tell us about the market. Comments on the just completed month will appear here while comments for the next month will be included in the "Tactical Models" section.
Our September allocations were typical of a bifurcated market. We needed global strength for a full allocation to equities; however we didn't have it. The Tactical Model likes domestic equities while avoiding all international equities which had negative TrendScores. It is also avoiding commodity related funds. During a bull market, fixed income generally carries lower TrendScores than equities so equities are preferred when all markets performing well. With no alternatives beyond domestic equities, the Model found opportunity to move out in duration from TBills to longer dated Treasuries and Investment Grade funds.
[Special note: I normally review the markets each weekend but took a quick look after Monday's close. Domestic Small/mid caps are increasingly diverging from the bigs which means the soldiers are not following the leaders. Also of note, the EM index and China appear to be finding a bid.]
The US equity market continues to struggle higher in the face of rising yields and competition from Fixed Income not to mention rising inflation and disruption to well-established global supply chains.
The $200B+ Federal deficit for August, coupled with declining tax receipts, appears to have been a wake up call for Treasury investors. The expiration of the temporary tax provision which encouraged corporate pension plans to inhale Treasuries did not help. Nor has the fact that foreign Central Banks have not been buying Treasuries for the past six months, leaving US investors to shoulder the entire burden of rising deficits.
I do think that odds favor a resurgence in the yield of the 10 Year Treasury and have a target at 3.45% and the odds of going there are higher than the market expects.
Outlook and Strategy
My general outlook is that Treasury rates will rise gradually until the markets blink. We'll know that the markets are blinking because the credit spreads will tell us. The Fed will blink afterward. A crash will see a flight to safety in Treasuries (lower yields again) while corporate and high yield go their own ways. Once the markets stabilize, Treasury rates are going to start rising again as debt, currency, and inflation issues take center stage.
Rising rates always cause dislocation in the credit markets as interest costs rise, profits decline, and the least credit worthy borrowers delay and default. With a historically high 75%+ of new loans being written with "lite" covenants and 45% of Investment Grade bonds carrying the lowest possible IG rating, the next credit contraction is certain to be painful. The next major decline in equities is likely to be driven by events in the credit markets.
A new White Paper on Adaptive Dynamic Momentum has been added to the Insights page.
The website has been completely updated for the new Global Tactical Strategy. I suggest a visit to the new Strategies page which does an excellent job of explaining the TAAS process.
The Proforma "Portfolio" page is updated in near real-time with daily and month-to-date performance. I generally get dividends posted within a day or two of x-date. This page now includes the date of the next Rebalance Notice as well as the next Rebalance Date.
The "Market Monitor" page is updated each weekend. It provides an updated assessment on the health of the equity market as well as interest rates, commodities, and precious metals.
Tactical Asset Allocation Strategy Performance
Global Adaptive Strategy
Month: 0.78% loss
Year-to-date: 4.83% gain
Full cycle-to-date (Sep 2007): 17.6% CAGR, 8.7% Max Monthly Drawdown