Tactical Asset Allocation – September 2021

Tactical Adaptive Strategies Update

Performance

Adaptive Global finished with a loss of 2.63% for the month and gain of 15.75% YTD. The strategy spent the month invested in domestic big caps, commodities, and Treasuries. Adaptive Global is our most broadly diversified “go anywhere” strategy with a 20+ year CAGR of 15.0%, a modest maximum monthly drawdown of 7.7%, and 9.4% standard deviation of monthly returns. The S&P 500 lost 4.66% for the month with a YTD gain of 15.91%. It has a 20+ year CAGR of 7.0%, maximum monthly drawdown of 50.8%, and a monthly standard deviation of 15.0%

Adaptive Income finished with a gain of 0.11% for the month and a gain of 8.03% YTD. Adaptive Income was invested entirely in senior loans. With a 20+ year CAGR of 9.9% and maximum monthly drawdown of 3.9%, 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 loss of 8.5%% for the month and loss of 9.74%% 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 22.4%, maximum monthly drawdown of 16.6%, and standard deviation of 16.5%.

Adaptive PM & BTC (Precious Metals and Bitcoin) finished with a loss of 4.05% and gain of 2.73% YTD. This is our newest niche strategy. With a standard deviation of 68.8%, this is our most volatile strategy; however the six year CAGR has been 64.1% with a 13.1% maximum monthly drawdown.

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

 

Perspective

Seemingly, the major issues ahead are Fed tapering of bond purchases and Fed interest rate increases, both based on Fed readings of the economy.

Allow me to share some thoughts to the contrary, all based on the fact that the US has an unsustainable debt load of 123%+- (and growing) of GDP. That’s $28 trillion in debt divided by $22.7 in GDP. There are two ways to get that debt load under control:

  • Reduce the debt over time via fiscal austerity (raise taxes and lower spending)
  • Depreciate the debt over time via Inflation

Consider the effects of attempting to impose austerity on an economy with a GDP growth rate barely above stall speed and a society which is already worried and badly fragmented. Will any Federal politician who wants to keep his/her job vote for austerity? Very unlikely!

An average inflation rate of 0% is required to maintain stable purchasing power. Until recently the Fed proclaimed a tolerance of a 2% upper limit. However, the Fed has recently established a 2% “average” inflation "target". 2% inflation means that a $100 bill will be worth just $82 ten years from now. It also means that each $100 in Federal debt will get an 18% haircut. Run inflation a bit hotter at say 4% and each $100 in Federal debt will get a 34% haircut. Meanwhile, GDP will continue growing, albeit slowly. That’s how the Federal government can avoid austerity while lowering its debt load from 123% of GDP.

Fed officials and politicians will tell you that inflation is both bad and transitory. Do not believe them. They understand  that inflation allows them the luxury of continuing to lavish funds upon taxpayers while depreciating the debt.

Unfortunately, rising inflation tends to drive rising interest rates because bondholders want to be compensated for the loss in purchasing power. Interest expense on the national debt coupled with expenditures for entitlement programs (Social Security, Medicare, and Medicaid) exceed tax receipts. The government can not afford an increase in interest expense.

Foreign buyers ceased taking their share of the growing Treasury debt in 2014. Domestic banking, money market funds, pension plans, and other financial institutions are already stuffed with Treasuries due to regulatory requirements. While domestic demand for Treasuries would likely increase with higher rates, the Federal government can not afford higher interest costs.

The Fed has a magic potion for this problem - the Fed balance sheet. Currently, the Fed’s balance sheet holds over one quarter of the nation’s $28 trillion in outstanding debt securities. The Fed is the buyer of last resort of Treasuries at below market rates.

Consider that if the Fed’s Treasury holdings were unloaded into the market, longer dated yields would jump.

Absent the extremely low probability of fiscal austerity, we can expect the Fed to maintain low interest rates and a growing balance sheet. Talk of material increases in interest rates and a declining balance sheet are just that ... talk.

The likely outcome over the next several years is non-transitory inflation, low yields, higher asset prices (excluding bonds) and increased volatility.

Tactical Asset Allocation was created to manage investments in just such an environment (mid 60’s to early 80’s) and should continue to serve investors well in the years ahead.

From the October 2nd Market Monitor

The big caps and housing were down sharply this week while small caps and banking were up. The big caps are bullish and falling on an intermediate basis while bullish and oversold on a short term basis. This suggests Friday’s rally may have more to run.

Cumulative Advancing Declining Volume turned up broadly this week which should be supportive of equity price increases. There are some early signs of relative strength in small versus big cap indexes which suggests that the market could see some funds shift into broader market indices.

The Credit Market Index declined sharply this week; however domestic spreads remain flat. This is showing the broad effects of rising rates; however increases in spreads are confined to emerging markets (think Evergrande fallout) and Europe. In short, domestic spreads indicate no stress in the US.

The 10 year Treasury pushed to a high of 1.57% this week but closed unchanged. The yield is clearly pointed higher.

The current list of caution flags once again shows some improvement :

  • The Speculation Index appears to have bottomed and turned up
  • The Russell 2000 has been trading in a tight sideways range since March. It is starting to look relatively bullish compared to the big cap indexes. Still, the big caps drive the overall market due to the sheer size of their collective market cap.
  • The big three market cap leaders AAPL, MSFT, and GOOGL remain strong, the next four are mixed.
  • Value is showing signs of getting a bid relative to growth
  • Consumer Discretionary remains better bid than Staples which is bullish
  • Inflation expectations remain high
  • Breadth is showing clear signs of a shift away from the few leaders
  • The S&P 500 shows 7 Distribution Days (0.2% decline on higher volume) in the past 30 trading days, with 0 Accumulation Days (1% rally on higher volume)
  • The ValueLine Weekly model remains on a sell signal in spite of recent new highs in the SPX
  • The VIX levels and signals are becoming more constructive.

There are a number of critical forces which are competing for influence in the Treasury market. These include inflation, threat of a rally in the US Dollar, the growing deficit, a debt ceiling which must be raised, and threats from the Fed to taper the growth of its balance sheet. A major shift in any one of these could quickly alter the trajectory of an equity market which exceeds all historical valuation measures. That said, the equity market is showing some signs of perking up.

Thank you for reading.

Earl Adamy