- The Market Climate Grader divides the environment for investment returns into four market climate zones.
- For better returns one should adjust asset allocation according to market climate. As an example, three models were analyzed to highlight the better performance when investing according to market climate.
- Performance for three models which use ETFs with varying risk characteristics are shown. Interestingly, risk measurements for the models are very similar, better than for the benchmarks and component ETFs.
- The simulated performance for all models is much higher than for buy-and-hold of the S&P500 or for the Vanguard LifeStrategy Moderate Growth Fund which holds 60% stocks and 40% bonds.
Market Climate Zones
There are four zones:
- Zone-1: PPP (positive)
- Zone-2: NPP (neutral-positive)
- Zone-3: NNP (neutral-negative)
- Zone-4: NNN (negative)
Figure-1 depicts the market climate zones as determined by our Market Climate Grader and also the performance of SPY. It is evident that during up-market periods Zone-1 prevailed most of the time, while during down-markets Zone-3 and Zone-4 were more often present. Recently the Grader switched from NNP to PPP.
Asset allocation should be in accordance with prevailing market climate. More aggressive (risky) ETFs can be used during up-market periods, while more conservative ETFs with less risk should protect and improve one’s investment during down-market periods.
The Standard ETF Models
Table-1 provides historic performance and risk statistics for our three standard models, Basic, Conservative, and Aggressive, as well as for the benchmarks VSMGX and SPY. A transaction cost of 0.10% of trade amounts was applied to provide for slippage and brokerage fees.
The Basic Model uses only two Vanguard ETFs in the four market climate zones. This resulted in 44 completed trades over the backtest period.
- They are the Vanguard Total Stock Market ETF (VTI),
- and the Vanguard Total Bond Market ETF (BND).
The Conservative Model uses four different ETFs, one for each climate zone. As a result 132 completed trades were generated for this model.
- They are the First Trust Health Care AlphaDEX Fund (FXH), and prior to its inception the Health Care Select Sector SPDR ETF (XLV),
- the Vanguard Total Stock Market ETF (VTI),
- the Utilities Select Sector SPDR ETF (XLU),
- and the iShares 7-10 years Treasury Bond ETF (IEF).
The Aggressive Model also uses four different ETFs.
- They are the 2x leveraged ProShares Ultra S&P500 (SSO),
- the SPDR S&P 500 ETF Trust (SPY),
- the Utilities Select Sector SPDR ETF (XLU),
- and the ProShares Short S&P500 (SH).
It is evident that each model significantly out-performed the benchmarks with less risk, as can be seen from Table-1. Noteworthy is that the risk measurements for all three models are very similar, while annualized returns for periods 3 years and longer are highest for the Aggressive model and lowest for the Basic model.
The performance of the Basic model which holds Vanguard index stock- and bond ETFs only, can be directly compared to that of the Vanguard LifeStrategy Moderate Growth Fund which holds 60% stocks and 40% bonds. The standard deviation of 4-week returns is about 10% for both, but Sharpe- and Sortino ratios, maximum drawdown, and annualized returns are much better for the Basic model – all achieved by following the Market Climate Grader and trading 44-times since January 2000.
Standard Model Performance
Tables-2, -3, and -4 provide performance and risk figures for the Basic, Conservative, and Aggressive models, respectively. Performance and risks for their relevant component ETFs are shown as well. It is evident that each model shows much higher returns than any of its component ETFs would have provided. This is also achieved with less risk as can be seen from the four risk measurements in the tables.
Following the Market Climate Grader Models
From our analysis it is apparent that structuring investments according to the market climate zones should provide better returns than ignoring market climate.
At our website imarketsignals.com, we will provide weekly information of the latest market climate zone as generated by the Market Climate Grader, together with performance updates for our three standard models.
One should be aware that most of the results shown are from a simulation. These models are presented for informational and educational purposes only and shall not be construed as advice to invest in any assets. Out-of-sample performance may be much different. Backtesting results should be interpreted in light of differences between simulated performance and actual trading, and an understanding that past performance is no guarantee of future results. All investors should make investment choices based upon their own analysis of the asset, its expected returns and risks, or consult a financial adviser.