Tactical Asset Allocation – September 2020

Tactical Adaptive Strategies Update

Performance

Treasury bonds (risk off) did well in September while everything else (risk on) did poorly.

Adaptive Global lost 2.21% for the month and has gained 0.19% YTD. Adaptive Global was invested in an eclectic mix of precious metals, big cap value, international real estate (all down), and long term Treasuries (up).  This was a 180 degree reversal from the previous month.

Adaptive Income gained 0.09% for the month and has gained 5.28% YTD.  Adaptive Income was invested in high yield which sold off but recovered into month-end.

Adaptive Innovation gained 0.50% for the month and gained 7.98% YTD. Adaptive Innovation split investments between intermediate and long term Treasuries.

Perspective

We are 5+ weeks away from what is expected to be a very contentious election and post-election period. Interestingly, our country has managed to survive eight contentious elections according to history.com. There is good reason to believe we’ll get through this one too.

The conditions under which our equity and bond markets are operating are clear and unlikely to change in the next few months, likely quite longer:

  • The Federal Reserve has assumed absolute control of the credit markets. Neither Treasury auctions nor junk bond issuers will be allowed to fail. Interest rates are at historical lows and the Fed has announced its determination to keep them there for years.
  • While election results may or may not offend our personal sensibilities, we have both parties engaged in ever increasing deficits differentiated only by the beneficiaries of the spending/tax cuts. There have been no apparent repercussions so the deficits will not only continue but increase with demands for everything from support payments to infrastructure.
  • Higher Treasury yields will blow out the Federal budget. Most of the US Treasury debt is of short duration which must be constantly refinanced because the market refuses to absorb a greater supply of longer duration at rates acceptable to the Treasury.

All of this boils down to the fact that the Fed will continue to grow its balance sheet in order to absorb the growing supply of Treasury issuance/rollover while suppressing yields by buying whatever the market will not take at the target yield. The Fed will also continue to “manage” yields and spreads across the full spectrum of quality in the credit markets. This should prove supportive for both the bond and equity markets even though the previously “hot stocks” appear to have fallen out of favor.

Ultimately, these policies are likely to yield the Fed’s desired inflation; however the negative effects are likely to be subdued until the economy recovers.

Our tactical adaptive strategies show an ability to weather remarkable and historical shifts in the market during the past two decades. I believe they can weather the next few months. Adaptive Global appears to have sniffed out the fact that SE Asia is getting back to normal while Adaptive Innovation moves back into selected ARK funds with volatility capped allocations.

Market

From the September 25th Market Monitor

"All major indexes were down with the exception of the NASDAQ 100 which rose 2%. The S&P 100 was down 0.1% and S&P 500 was down 0.6% while the S&P 400 (mid cap) was down 2.6% and the S&P 600 (small cap) was down 4.1%. In a nutshell, strength is once again concentrated in the mega and big cap stocks.

Both intermediate and short term trends in the big caps remain bullish. While intermediate term momentum has room to decline further, short term momentum is now oversold with bullish divergences. Our downside S&P 500 target of 3235 has been met. While the decline could extend to our extreme target at 3120; the decline is more likely to complete near our next downside target of 3192.

Cumulative Advancing Declining Volume is declining faster than price which suggests prices have further to fall. That said, CADV shows no signs of a deep, sustained decline. This confirms the moderate correction thesis.

Credit markets weakened this week with higher yields and wider spreads. This could be problematic should the rise accelerate.

The US Dollar continues its re-test of the previously broken long term trendline. A dollar rally would be negative for equities, energy, and metals. There are signs that a new stimulus deal may be reached by early next week which would be dollar negative.

The Ten Year Treasury continues to wander within a tight range of 0.5% to 0.7% for a negative real yield of -0.6% to - 0.8%.

VIX is elevated and the curve points higher into the election followed by a modest decline. That said, our VIX Model has yet to issue a sell signal."

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)