- 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.
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- 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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