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Expect Further Losses For Stocks And Very Low 10-Year Forward Returns: Update June 2022

  • The average of S&P 500 for May 2022 was 4,040 (14% down from December 2021 average) and is still 1,469 points higher than the corresponding long-term trend value of 2,571.
  • For the S&P 500 to reach the long-trend would entail a 36% decline from the May average value, possibly over a short period.
  • The Shiller CAPE-ratio is at a level of 31.0. That is 21% higher than its 35-year moving average (MA35), currently at 25.6.
  • The CAPE-MA35 ratio is at 1.21 (down from the December 2021 level of 1.51), forecasting a 10-year annualized real return of about 6.3%.
  • However, rising inflation with a falling CAPE-MA35 ratio, similar to what occurred in the period 1964-1973, implies very low or negative 10-year forward annualized real returns.
  • The historic long-term trend indicates a 10-year forward real annualized return of only 1.9% (up from the December 2021 forecast of 0.2%).

Posted in 2020, blogs, featured

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.

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Evaluating Popular Asset Classes for Inflation Protection

  • We tested nine asset classes which are supposed to provide protection against inflation according to an Investopedia article. The test period was from January 2005 to May 2022.
  • Investopedia provides no definition for inflationary environment, but this analysis uses the 6-month moving average of the inflation rate and the University of Michigan: Inflation Expectation© series to define it.
  • For this investigation we consider separately the inflationary periods which fall within the Risk-on and Risk-off phases for equities, as defined by the iM-Multi-Model Market Timer.
  • From the asset classes listed by Investopedia only the Vanguard Real Estate ETF (VNQ) provided some inflation protection relative to the SPDR S&P 500 ETF (SPY).
  • Better inflation protection is provided by energy sector ETFs XLE and PXE, but energy sector funds were not among the asset classes listed in the Investopedia article.

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The Stock Market Has Peaked, S&P 500 Death Cross For The Ides Of March: Update March 2022

  • The average of S&P 500 for February 2022 was 4436 (5% down from December 2021 average) and is still 1896 points higher than the corresponding long-term trend value of 2540.
  • A reversal to the long-trend would entail a 43% decline, possibly over a short period aggravated by the imminent S&P500 death cross.
  • The Shiller CAPE-ratio is at a level of 35.9 (down 7.2% from its recent peak of 38.7). That is 41% higher than its 35-year moving average (MA35), currently at 25.5.
  • The CAPE-MA35 ratio is 1.41 (down from the end of December 2021 level of 1.51), forecasting a 10-year annualized real return of about 4.6%.
  • The historic long-term trend indicates a 10-year forward real annualized return of only 0.8% (up from the end of December 2021 forecast of 0.2%).

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The iM-Multi-Model Market Timer – Not Your Daddy’s Old Moving Average Crossover System

  • Reliance on a single market timer is risky. The risk can be reduced by a multi-model market timer whose many components use different and uncorrelated financial and economic data.
  • This model seeks to determine reliable risk-on and risk-off periods for the stock market. When there is no definite signal for risk-on or risk-off then the investment is considered risk-neutral.
  • From 2000 to 2022, switching between ETFs RSP, VGT, SH, TIP, BIV and IEF would have produced an annualized return of 34.2% versus 7.0% for buy and hold SPY.
  • The model is not a binary indicator between risk-on and risk-off and does not rely on leveraged ETFs to produce such high returns.

Posted in 2020, blogs, featured

Consumer Staples/Discretionary Spending As A Reliable And Profitable Stock Market Timer

  • The difference in return of the Consumer Staples- and the Consumer Discretionary sectors can provide risk-on and risk-off signals for equity investment.
  • Four time series sets are used: ETFs XLP & XLY, Portfolio 123 Specialty SP1500 Consumer Staples & Consumer Discretion, Aggregate Series Non-Cyclical & Cyclicals, and ETFs RHS & RCD.
  • Investment in equities is signaled when the 15 week return of the discretionary sector outperformed the staples sector’s return.
  • From 5/1/1999 to 10/1/2021 this strategy, when accordingly switching between ETF SPY and ETF IEF, would have produced a 14.9% annualized return with a maximum drawdown of -17%.

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Beating the S&P 500 with Fixed Income ETFs alone

  • This model only holds fixed income asset class ETFs, never equity. It significantly out-performs the S&P 500 ETF (SPY) over longer periods by strategically switching holdings for risk-on and risk-off situations.
  • It uses three previously published market timing algorithms, the ModSum Timer, the YieldCurve Timer, and the Cyclically Adjusted Risk Premium (CARP) to define risk-on, risk-off, and hedging periods.
  • During risk-on periods, as indicated by the ModSum Timer and the CARP, the model holds the SPDR Bloomberg Barclays Convertible Securities ETF (CWB).
  • During risk-off periods the model switches to iShares 20+ Year Treasury Bond ETF (TLT).
  • Near, or during recession periods, as indicated by the YieldCurve Timer, the model is hedged with the iShares 7-10 Year Treasury Bond ETF (IEF), irrespective of the risk situation.

The strategy described here demonstrates that contrary to the accepted believe investing in fixed income can produce superior returns to equity investments.  This model uses three previously published market timing algorithms to define risk-on, risk-off, and hedging periods.
Read more >

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The Cyclically Adjusted Risk Premium As An Indicator of Market Risk

  • The accepted thinking is that the additional risk inherent in stocks is reflected by a “Risk Premium”, being the difference of S&P expected earnings yield and the 10-year note yield.
  • 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-off and risk-on assets and avoid major stock market losses.
  • Prior to the Financial Crisis of 2007-2008 the CARP indicated a “risk-off” asset allocation, in contrast to the S&P Risk Premium which signaled that stocks were undervalued.
  • More recently, at end of February 2021, the CARP has signaled the end of embracing risk-on assets and a switch to risk-off assets.

The S&P Risk Premium and below statement comes from Portfolio 123:
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The iM-3 Position SuperCombination Timer

  • This Combination Timer seeks to find optimum investment periods for equities. It uses five market timing algorithms, previously described, to periodically invest in three ETFs from a possible 16 available.
  • It can hold equity, gold, and fixed income ETFs depending on stock market direction as indicated by a combination of market timers.
  • A backtest from January 2000 to July 2021 shows an annualized return of 24.5% with a maximum drawdown of -23% and low annual turnover of 140%.

Posted in blogs, featured

The Overvalued S&P 500 Signals Low 10-Year Forward Returns: Update May 2021 

  • The average of S&P 500 for April 2021 was 4141. This is 1701 points higher than the long-term trend value of 2440.
  • The current percentage difference of S&P 500 level relative to the current long-term trend level is 70%, a value never exceeded in the recent past since August 2001.
  • The Shiller Cyclically Adjusted Price to Earnings Ratio (CAPE) is at a level of 37.0. That is 49% higher than its 35-year moving average (MA35), currently at 24.9.
  • The CAPE-MA35 ratio is 1.49, forecasting a 10-year annualized real return of about 4.0%. Should the CAPE-MA35 ratio increase further, then 10-year forward returns will be even lower.

Posted in blogs, featured
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