The iM-Inflation Attuned Multi-Model Market Timer

  • Investment risk can be reduced by a multi-model market timer whose many components use different and uncorrelated financial and economic data, including inflation.
  • This model seeks to determine effective asset allocation for risk-on and risk-off periods for equities considering the effect of inflation.
  • Four risk scenarios are possible: risk-on & normal-inflation, risk-on & high-inflation, risk-off & normal-inflation, and risk-off & high-inflation. Different ETF groups apply to each risk scenario.
  • From 2000 to 2022, switching accordingly between risk-related ETF groups would have produced an annualized return of about 39% versus 6.5% for buy and hold SPY.

Basic risk-on and risk-off signals for equities

Previously described market timing models (listed in Appendix-1) are used to determine the basic risk-on and risk-off periods for equities, similarly to what was described in the iM-Multi-Model Market Timer article.

For this model signals for basic risk-on situations arise when either

  • the Inflation Lower Timer plus the Consumer Sentiment Timer, or
  • the Cyclically Adjusted Risk Premium Timer, or
  • the SuperTimer indicate this, otherwise

if none of the above three options are true basic risk-off periods are indicated.

Inflation considerations

During risk-on and risk-off periods for equities one should consider inflation risk as well. Rising inflation means that interest rates are increasing and the discounted value of future cash flows from stocks is driven down, lowering equity prices.

Higher inflation, or an inverted yield curve signal a higher risk environment for equities.

We define rising inflation with data from the University of Michigan Inflation Expectation© series (MICH) and the 6-month moving average of the inflation rate as discussed in Evaluating Popular Asset Classes For Inflation Protection.

Typically, the Federal Funds Rate is near a high when the yield curve inverts, indicating the Federal Reserve’s activity in combating high inflation. An inverted yield curve signifies that economic activity is near the end of the expansion phase of a business cycle and that a high probability of an oncoming recession exists.

For this model “high-inflation” is defined when the value of MICH is greater than 3.1% and the 6-month moving average of the inflation rate is greater than 2.9%, or the yield curve is near inversion or inverted as indicated by the Yield Curve Timer, all data point-in-time. When “high-inflation” is not present then “normal-inflation” is assumed.

Risk environments and risk-related asset allocation

The following ETFs were used:

  1. Invesco S&P 500 Equal Weight ETF (RSP)
  2. Vanguard Information Technology Index Fund (VGT)
  3. Vanguard Real Estate Index Fund (VNQ)
  4. Invesco Dynamic Energy Exploration & Production ETF (PXE)
  5. ProShares Short Russell2000 (RWM)
  6. iShares 20+ Year Treasury Bond ETF (TLT)
  7. ProShares Short S&P500 (SH)
  8. ProShares Short QQQ (PSQ)
  9. Vanguard Mid-Cap Value Index Fund (VOE) and Invesco DB Commodity Index Tracking Fund (DBC) as proxies for VGT and PXE prior to their inception dates, respectively.

The four possible risk environments and corresponding risk-related ETF groups are:

  1. risk-on & normal-inflation: RSP & VGT
  2. risk-on & high-inflation: VNQ & PXE
  3. risk-off & normal-inflation: RWM & TLT
  4. risk-off & high-inflation: SH & PSQ

Note that the model never holds any leveraged ETFs.

Performance of the Inflation Attuned Multi-Model Market Timer

The model was backtested using the online portfolio simulation platform Portfolio 123, which also provides extended price data for ETFs prior to their inception dates calculated from their proxies. Closing prices and trading costs of 0.05% of each trade amount were assumed in the backtest.

The simulated performance of the model is shown in Figure-1 below. The red graph represents the performance of the model from Jan 3, 2000 to May 11, 2022 (22+ years) and the blue graph, which resembles a horizontal line, shows the performance of benchmark SPY.

The simulation shows an annualized return of 39% with a maximum drawdown of -22% and only 169 realized trades (a listing of realized trades is in the Appendix-2). An initial investment of $100,000 would have grown to $160-million if one could have followed this model from January 2000 onwards. Total trading costs would have been $850,000.

width="640"/(click to enlarge)

Risk Measurements

The risk statistics for the model relative to the benchmark ETF (SPY) show a positive alpha of 36%, indicating that this strategy would have outperformed its risk-adjusted benchmark return on average by 36% per year since January 2000. Additionally, the Standard Deviation for this model’s monthly returns is similar to that of SPY, indicating similar volatility and demonstrating that the model’s investment strategy should be a better alternative to buy-and-hold SPY over the longer term.

Conclusion

From the analysis it would appear that the Inflation Attuned Multi-Model Market Timer could profitably be used to switch between the specified ETF groups according to the signaled risk situation. This model’s calendar year returns ranged from a minimum of 11% in 2018 to a maximum of 152% in 2008. The model shows excess returns over benchmark SPY for each year, and there would never have been a year with negative returns.

From Jan 3 to May 11, 2022 the model shows a gain of 26% versus a loss of 17% for SPY.

At iMarketSignals we will report weekly the status of this timer. Gold subscription would be required.  The last trade, switching from risk-on & high-inflation to risk-off & high-inflation occurred on 5/2/2022, and current holdings are therefore SH and PSQ since then.

Although this model performed extremely well over 22 years, there is no guarantee that it will perform well in the future.

Appendix-1

Market timing models used:

  1. Consumer Sentiment Timer : Investment in equities is signaled when the 15-week return of the discretionary sector outperforms the 15-week return of the staples sector.
  2. Cyclically Adjusted_RiskPremium Timer : An alternative measure of risk is the Cyclically Adjusted Risk Premium (CARP), defined as the inverse of the Shiller CAPE Ratio (CAPE) in percent minus the 10-year note yield. The value of the CARP and directional trend of the CAPE can be used to profitably time investments in risk-on and risk-off assets.
  3. Composite Market Timer : An entry for the stock market is signaled when the combined weight of its six component models is equal to, or greater than 50%. This model has the greatest weight in the SuperTimer.
  4. SuperTimer : A weekly Stock Market Confidence Level (SMC level) is obtained by considering the percentage allocated to each of its 15 component timer model and their weight in the system. Positive stock market investment climates are indicated by SMC levels greater than 50%.
  5. Inflation Lower Timer : Normally equities perform better when inflation is lower.
  6. Yield Curve Timer: The timing rules are based on the state of yield curve and on the trend of the Effective Federal Funds Rate.

Appendix-2

Realized trades:

Trade # Symbol Open Close Days Pct Return
169 PXE 9/7/2021 5/2/2022 237 68.90%
168 VNQ 9/7/2021 5/2/2022 237 -7.60%
167 VGT 4/13/2020 9/7/2021 512 90.10%
166 RSP 4/13/2020 9/7/2021 512 72.20%
165 VGT 9/23/2019 3/2/2020 161 14.20%
164 RSP 9/23/2019 3/2/2020 161 -1.10%
163 PXE 9/9/2019 9/23/2019 14 2.20%
162 VNQ 9/9/2019 9/23/2019 14 0.50%
161 VGT 1/7/2019 9/9/2019 245 29.40%
160 RSP 1/7/2019 9/9/2019 245 15.50%
159 TLT 12/10/2018 1/7/2019 28 1.20%
158 RWM 12/31/2018 1/7/2019 7 -4.30%
157 RWM 12/10/2018 12/24/2018 14 13.20%
156 VGT 2/1/2016 12/10/2018 1043 72.00%
155 RSP 2/1/2016 12/10/2018 1043 34.20%
154 RWM 12/7/2015 2/1/2016 56 11.40%
153 TLT 12/7/2015 2/1/2016 56 3.90%
152 VGT 10/5/2015 12/7/2015 63 8.30%
151 RSP 10/5/2015 12/7/2015 63 2.50%
150 TLT 9/28/2015 10/5/2015 7 -0.70%
149 RWM 9/28/2015 10/5/2015 7 -4.60%
148 VGT 8/24/2015 9/28/2015 35 1.60%
147 RSP 8/24/2015 9/28/2015 35 -2.00%
146 RWM 7/6/2015 8/24/2015 49 11.20%
145 TLT 7/6/2015 8/24/2015 49 6.80%
144 RSP 7/2/2012 7/6/2015 1099 60.80%
143 VGT 7/2/2012 7/6/2015 1099 54.10%
142 VNQ 3/5/2012 7/2/2012 119 6.80%
141 PXE 3/5/2012 7/2/2012 119 -9.80%
140 VGT 2/6/2012 3/5/2012 28 3.00%
139 RSP 2/6/2012 3/5/2012 28 0.40%
138 PXE 10/3/2011 2/6/2012 126 39.40%
137 VNQ 10/3/2011 2/6/2012 126 30.10%
136 VGT 9/6/2011 10/3/2011 27 -2.70%
135 RSP 9/6/2011 10/3/2011 27 -8.30%
134 RSP 8/8/2011 8/15/2011 7 8.80%
133 VGT 8/8/2011 8/15/2011 7 7.70%
132 RWM 6/13/2011 8/8/2011 56 16.30%
131 TLT 6/13/2011 8/8/2011 56 9.10%
130 RSP 6/14/2010 6/13/2011 364 19.60%
129 VGT 6/14/2010 6/13/2011 364 15.10%
128 RWM 5/3/2010 6/7/2010 35 15.90%
127 TLT 5/3/2010 6/7/2010 35 7.40%
126 RSP 2/8/2010 5/3/2010 84 17.50%
125 VGT 2/8/2010 5/3/2010 84 15.20%
124 RWM 1/4/2010 2/8/2010 35 8.40%
123 TLT 1/4/2010 2/8/2010 35 2.40%
122 RSP 3/23/2009 1/4/2010 287 56.60%
121 VGT 3/23/2009 1/4/2010 287 56.50%
120 VGT 1/5/2009 2/23/2009 49 -12.20%
119 RSP 1/5/2009 2/23/2009 49 -21.40%
118 PXE 12/15/2008 1/5/2009 21 16.30%
117 VNQ 12/15/2008 1/5/2009 21 5.10%
116 VNQ 12/1/2008 12/8/2008 7 40.50%
115 PXE 12/1/2008 12/8/2008 7 -0.10%
114 PSQ 9/2/2008 11/3/2008 62 27.00%
113 SH 9/2/2008 11/3/2008 62 21.50%
112 VNQ 8/4/2008 9/2/2008 29 4.40%
111 PXE 8/4/2008 9/2/2008 29 -1.00%
110 SH 6/2/2008 8/4/2008 63 9.90%
109 PSQ 6/2/2008 8/4/2008 63 9.80%
108 PXE 3/17/2008 6/2/2008 77 28.40%
107 VNQ 3/17/2008 6/2/2008 77 9.60%
106 SH 2/4/2008 3/17/2008 42 7.30%
105 PSQ 2/4/2008 3/17/2008 42 7.10%
104 TLT 10/15/2007 2/4/2008 112 2.00%
103 RWM 1/28/2008 2/4/2008 7 -3.10%
102 RWM 10/15/2007 1/22/2008 99 22.40%
101 VGT 9/10/2007 10/15/2007 35 7.60%
100 RSP 9/10/2007 10/15/2007 35 5.90%
99 RWM 7/23/2007 9/10/2007 49 8.70%
98 TLT 7/23/2007 9/10/2007 49 5.90%
97 VGT 6/4/2007 7/23/2007 49 4.90%
96 RSP 6/4/2007 7/23/2007 49 -1.40%
95 PXE 5/14/2007 6/4/2007 21 8.20%
94 VNQ 5/14/2007 6/4/2007 21 0.60%
93 VGT 2/5/2007 5/14/2007 98 5.10%
92 RSP 2/5/2007 5/14/2007 98 4.70%
91 VNQ 12/26/2006 2/5/2007 41 11.00%
90 PXE 12/26/2006 2/5/2007 41 0.80%
89 RSP 12/11/2006 12/26/2006 15 -0.70%
88 VGT 12/11/2006 12/26/2006 15 -1.50%
87 PXE 10/9/2006 12/11/2006 63 15.90%
86 VNQ 10/9/2006 12/11/2006 63 7.80%
85 SH 9/5/2006 10/9/2006 34 -2.30%
84 PSQ 9/5/2006 10/9/2006 34 -4.90%
83 VNQ 7/3/2006 9/5/2006 64 5.90%
82 PXE 7/3/2006 9/5/2006 64 0.50%
81 PSQ 6/26/2006 7/3/2006 7 -1.80%
80 SH 6/5/2006 7/3/2006 28 -0.80%
79 TLT 5/22/2006 6/5/2006 14 0.00%
78 RWM 5/22/2006 6/5/2006 14 -0.50%
77 RSP 2/6/2006 5/22/2006 105 -0.40%
76 VGT 2/6/2006 5/22/2006 105 -4.60%
75 PXE 11/7/2005 2/6/2006 91 19.00%
74 VNQ 11/7/2005 2/6/2006 91 10.10%
73 VGT 9/6/2005 11/7/2005 62 1.60%
72 RSP 9/6/2005 11/7/2005 62 -1.50%
71 DBC 5/2/2005 9/6/2005 127 23.00%
70 VNQ 5/2/2005 9/6/2005 127 13.10%
69 VGT 4/18/2005 5/2/2005 14 1.40%
68 RSP 4/18/2005 5/2/2005 14 1.10%
67 RWM 2/28/2005 4/18/2005 49 16.20%
66 TLT 2/28/2005 4/18/2005 49 1.00%
65 RSP 10/25/2004 2/28/2005 126 11.90%
64 VGT 10/25/2004 2/28/2005 126 4.30%
63 TLT 9/13/2004 10/25/2004 42 2.70%
62 RWM 9/13/2004 10/25/2004 42 -0.60%
61 RSP 8/9/2004 9/13/2004 35 6.30%
60 VGT 8/9/2004 9/13/2004 35 5.80%
59 RWM 6/28/2004 8/9/2004 42 25.00%
58 TLT 6/28/2004 8/9/2004 42 4.60%
57 RSP 5/24/2004 6/28/2004 35 4.60%
56 VGT 5/24/2004 6/28/2004 35 4.10%
55 RWM 4/19/2004 5/24/2004 35 11.50%
54 TLT 4/19/2004 5/24/2004 35 -2.90%
53 RSP 9/22/2003 4/19/2004 210 15.60%
52 VGT 2/2/2004 4/19/2004 77 -7.30%
51 VOE 9/22/2003 2/2/2004 133 12.20%
50 TLT 9/2/2003 9/22/2003 20 3.40%
49 RWM 9/2/2003 9/22/2003 20 -3.00%
48 RSP 3/3/2003 9/2/2003 183 33.20%
47 VOE 3/3/2003 9/2/2003 183 30.20%
46 RWM 11/25/2002 3/3/2003 98 22.30%
45 TLT 11/25/2002 3/3/2003 98 5.00%
44 RSP 10/14/2002 11/25/2002 42 18.20%
43 VOE 10/14/2002 11/25/2002 42 10.20%
42 TLT 4/1/2002 10/7/2002 189 13.40%
41 RWM 8/12/2002 9/23/2002 42 13.40%
40 RWM 4/1/2002 7/15/2002 105 45.50%
39 VOE 3/18/2002 4/1/2002 14 -0.20%
38 RSP 3/18/2002 4/1/2002 14 -0.50%
37 TLT 3/4/2002 3/18/2002 14 -2.50%
36 RWM 3/4/2002 3/18/2002 14 -6.10%
35 VOE 12/24/2001 3/4/2002 70 5.10%
34 RSP 12/24/2001 3/4/2002 70 4.40%
33 RWM 10/8/2001 12/24/2001 77 -30.20%
32 TLT 8/20/2001 12/24/2001 126 -1.20%
31 RWM 9/17/2001 9/24/2001 7 11.00%
30 RWM 8/20/2001 9/10/2001 21 17.30%
29 VOE 8/6/2001 8/20/2001 14 -1.80%
28 RSP 8/6/2001 8/20/2001 14 -2.00%
27 SH 7/2/2001 8/6/2001 35 2.70%
26 TLT 5/7/2001 7/2/2001 56 0.10%
25 RWM 5/7/2001 7/2/2001 56 -5.10%
24 VOE 4/23/2001 5/7/2001 14 5.40%
23 RSP 4/23/2001 5/7/2001 14 3.40%
22 RWM 4/2/2001 4/23/2001 21 -10.60%
21 TLT 1/16/2001 4/23/2001 97 -1.80%
20 RWM 1/16/2001 3/19/2001 62 17.10%
19 SH 11/27/2000 1/16/2001 50 1.10%
18 RWM 11/6/2000 11/27/2000 21 12.80%
17 TLT 11/6/2000 11/27/2000 21 2.60%
16 SH 10/30/2000 11/6/2000 7 -2.40%
15 TLT 10/16/2000 10/30/2000 14 0.90%
14 RWM 10/16/2000 10/30/2000 14 -1.10%
13 SH 10/2/2000 10/16/2000 14 4.30%
12 RWM 9/18/2000 10/2/2000 14 1.40%
11 TLT 9/18/2000 10/2/2000 14 0.40%
10 SH 8/28/2000 9/18/2000 21 4.90%
9 TLT 7/3/2000 8/28/2000 56 2.80%
8 RWM 7/3/2000 8/28/2000 56 -2.00%
7 SH 6/19/2000 7/3/2000 14 1.10%
6 VNQ 6/5/2000 6/19/2000 14 3.10%
5 DBC 6/5/2000 6/19/2000 14 0.00%
4 VOE 4/17/2000 6/5/2000 49 11.20%
3 RSP 4/17/2000 6/5/2000 49 7.60%
2 TLT 1/3/2000 4/17/2000 105 8.50%
1 RWM 1/3/2000 4/17/2000 105 6.90%

Note that Pct Return does not include dividends.

 

 

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29 comments on “The iM-Inflation Attuned Multi-Model Market Timer
  1. yossarian says:

    Fascinating, thank you. I’ll be tuning in weekly.

  2. yossarian says:

    Another aspect that jumps out is that there are only three trades of 169 in 22+ years that would trigger a -10% stop loss safeguard.

  3. maspap says:

    Hi, you reported -22% as max drawdown but trades 33/38 show greater losses.
    By the way do you mind adding yearly returns as you always did before.
    Thank you.

    • TDCARLSON says:

      As I understand it trade 33 (and all the trades) are only 50% of the portfolio in general, so 22% drawdown seems reasonable.

      Tom C

    • geovrba says:

      Return (%) *** Model *** Benchmark *** Excess
      2000 *** 43.43 *** -9.74 *** 53.17
      2001 *** 17.65 *** -11.76 *** 29.41
      2002 *** 69.12 *** -21.58 *** 90.7
      2003 *** 56.35 *** 28.18 *** 28.17
      2004 *** 50.14 *** 10.7 *** 39.44
      2005 *** 33.98 *** 4.83 *** 29.15
      2006 *** 17.76 *** 15.85 *** 1.91
      2007 *** 45.78 *** 5.15 *** 40.64
      2008 *** 151.9 *** -36.79 *** 188.69
      2009 *** 32.18 *** 26.35 *** 5.83
      2010 *** 64.63 *** 15.06 *** 49.57
      2011 *** 43.14 *** 1.89 *** 41.24
      2012 *** 17.42 *** 15.99 *** 1.43
      2013 *** 32.86 *** 32.31 *** 0.55
      2014 *** 15.58 *** 13.46 *** 2.12
      2015 *** 14.79 *** 1.23 *** 13.56
      2016 *** 29.39 *** 12 *** 17.39
      2017 *** 27.26 *** 21.71 *** 5.55
      2018 *** 10.95 *** -4.57 *** 15.52
      2019 *** 38.33 *** 31.22 *** 7.11
      2020 *** 46.02 *** 18.33 *** 27.69
      2021 *** 37.45 *** 28.73 *** 8.72
      2022 *** 27.62 *** -19.33 *** 46.95
      to 06/30/22

  4. RobertFairchild says:

    Hi,
    Perhaps I’m mistaken but it appears that the model sometimes goes to a partial cash position.
    For instance trades 155-159:
    – Trades 156 & 156 close on 12/10/2018 and open into trades 157 & 159.
    – Trade 157 appears to close on 12/24, but doesn’t open into Trade 158 until 12/31/2018.
    – Trades 158 & 159 close on 1/7/2019
    So there was a period from 12/24 -> 12/31 with a %50 cash allocation.
    12/24/2018 was an early close, so trading should have been possible.

    • bmatkins44 says:

      I also have this same question. The most glaring spot to me is between trades 164 and 165 (which were closed on 3/2/20) and 166 and 167 (which were opened on 4/13/20). Right in the middle of the COVID meltdown and start of the bounce back.

      • geovrba says:

        The model can only be in Risk-On when the drawdown over 25 days of benchmark SPY is better than -12% x (a moving average factor). So there are a few periods when it is out of Risk-On.

  5. GM says:

    why not consider GOLD etf as one of the asset allocation?

    • geovrba says:

      The article from Wells Fargo: Here’s The Best Asset To Own When Inflation Strikes lists Oil (USO) and Emerging Markets (VWO) as the two best performers during periods of inflation post 2000.

      We found that for risk-on periods during inflationary times the Dynamic Energy Exploration & Production ETF (PXE) does better than USO and the Real Estate ETF (VNQ) also is also a better choice than VWO.

  6. Kyatoro says:

    When will this model be available?

  7. Oakbrook says:

    The chart states that the model is “rebalanced every week”. Does that mean that the 2 positions are balanced on a dollar basis when the ETF’s do not change?

    • geovrba says:

      This model sets Min Rebalance Transaction to 50.00% which eliminates all rebalancing transactions.

      Thus the weights are set only at the time when new buys occur (equal weight). Weighting for a position can become higher or lower than 50% depending on the relative performance of the two ETFs over time.

  8. Kyatoro says:

    How come sometimes there are no positions for a while?

    An an example, we can see that on 02/23/2008 we sell RSP/VGT and we buy them again only on 3/23/2008. Is there a reason to explain why we were 1 month without any position? Is there a rule to sell and stay cash?

    Thank you.

    • geovrba says:

      The model can only be in Risk-On when the drawdown over 25 days of benchmark SPY is better than -12% x (moving average factor). So there are a few periods when it is out of Risk-On.

  9. TedWrinch says:

    Thanks, Anton, this strategy is a significant improvement over it’s predecessor for high inflation environments like now. From my calculation, the previous strategy lost -5% from September to now, when the market went into reverse, whereas this strategy gained 30%, the difference being due to including the energy and property ETFs. From UK, I don’t have access to these ETFS so I use equivalents, which seems to work as well.

    • Lucror1 says:

      Hi Ted,

      I was just wondering which UK equivalent ETFs you use? I am also based in the UK and I can’t seem to find an equivalent of some of the above ETFs (e.g. PSQ).

      Any help would be appreciated.

      Cheers

      • TedWrinch says:

        Sorry for the delay, apparently no e-mail notifications here. I use XSPS.L, XSPS.L risk-off, high inflation; XSD2.L, VVUKLD risk-off, low inflation; ENCG.L, ENCG.L risk-on, high inflation; iGUS.L, EQQQ.L risk-on, low inflation.

  10. bmatkins44 says:

    Has any one had their questions answered, especially regarding missing dates? As a paying customer, I expect better service and at least some type of response.

  11. Golar says:

    I`m new to this website so maybe some members can explain the current holdings in the Multi-Model.

    On 5-2-22 SH was bought then 50% of that position was sold on the same date.Also on 5-2 PSQ was bought.

    So, are the current holdings 25% cash, 25% SH and 50 % PSQ ?. If this is correct was the 50% SH position held for 2 weeks and then reduced to a 25% position per the holding rule ?

    Anyone that can help with this is much appreciated

    • geovrba says:

      Current holdings are:
      PSQ 50%
      SH 50%

      On 5/2/2022 the model sold PXE and VNQ.
      On 5/2/2022 the model bought PSQ and SH, each having a weight of 50%.

      Our report states that on 5/2/2022:
      Buy SH and sell 50% SH = Buy 50% SH
      Buy 50% PSQ

  12. Golar says:

    Thank You for the clarification

  13. Longtermview says:

    Hi Georg and Anton, I just want to check if this model here is different from the model that was recently added to P123 named: 12 Russell 3000 stocks – Inflation Attuned?

    Thank you.

    • geovrba says:

      Yes, it is totally different.
      The model on P123 is a 12-stock model hedged with SH.
      The Inflation Attuned Market Timer is an ETF model, it never holds individual stocks.

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