Blog Archives

How to Avoid the Coming Bear Market Indicated by Shiller’s CAPE Ratio: Update December 2017

  • The Cyclically Adjusted Price to Earnings Ratio (CAPE ratio) is at 32.1, a very high level which signals overvaluation of stocks and low forward returns, according to Shiller.
  • This level was only exceeded twice in the last 136 years, in Sep-1929 and from Jul-1997 to Jul-2001, with market declines of 77% and 45% then recorded.
  • The Moving Average CAPE Ratio Methodology used here references stock market valuation to a 35-year moving average of the Shiller CAPE ratio instead of the 1881-2017 long-term average.
  • Based on the 35-year moving average methodology, historic market performance points towards continuing up-market conditions, possibly for a number of years.
  • To avoid the bear market, exit stocks when the spread between the 5-month and 25-month moving averages of S&P-real becomes negative and simultaneously the CAPE-Cycle-ID score is 0 or -2.

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Improve on Vanguard LifeStrategy Growth Funds with a Dynamic Strategy

  • The founder of Vanguard, Jack Bogle, says that over the next decade a conservative portfolio of bonds will only return about 3% a year and stocks about 4% a year.
  • However, returns can be improved with a dynamic asset-allocation strategy that adjusts stock- and bond-fund holdings in a retirement account according to market climate.
  • The Vanguard LifeStrategy Moderate Growth Fund (VSMGX) holds static investments of 60% equity and 40% bond funds and is compared to our dynamic strategy model.
  • Our iM-DMAC(60:40) model, designed for retirement saving and withdrawal management, holds identical assets as VSMGX in up-market conditions but switches to 100% bond funds during equity down-market periods.
  • The result, the iM-DMAC(60:40) vastly outperforms VSMGX.

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How to Avoid the Coming Bear Market Indicated by Shiller’s CAPE Ratio

  • The Cyclically Adjusted Price to Earnings Ratio (CAPE ratio) is at 30.2, a very high level which signals overvaluation of stocks and low forward returns, according to Shiller.
  • This level was only exceeded twice in the last 136 years, from Aug-1929 to Sep-1929 and from Jun-1997 to Jan-2002, with market declines of 77% and 45% then recorded.
  • The Moving Average CAPE Ratio Methodology used here references stock market valuation to a 35-year moving average of the Shiller CAPE ratio instead of the 1881-2017 long-term average.  
  • Based on the 35-year moving average methodology, historic market performance points towards continuing up-market conditions, possibly for a number of years.
  • To avoid the bear market, exit stocks when the spread between the 5-month and 25-month moving averages of S&P-real becomes negative and simultaneously the CAPE-Cycle-ID score is 0 or -2.

Shiller warns in his recent commentary The Coming Bear Market? :
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The 3ETF-Trader plus

  • This system holds three ETFs according to stock market climate.
  • Typically, during good-equity markets it holds equity- and leveraged-equity ETFs SPY, SSO, and UPRO.
  • During bad-equity markets it holds leveraged short equity, short equity, and gold-ETFs SDS, SH, and GLD.
  • It never holds fixed income ETFs, so we don’t have to worry about rising rates.

The model was backtested on the on-line simulation platform Portfolio 123 which also provides extended price data for ETFs prior to their inception dates calculated from their proxies. Trading costs, including slippage, were assumed as 0.1% of the trade amounts using closing prices.
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Profiting from Market Volatility with the “Anti-VIX” ETN ZIV

  • The “Anti-VIX” ETN ZIV is designed to increase in value when the volatility of the S&P 500 decreases, as measured by the prices of VIX futures contracts.
  • The model buys ZIV only during up-markets when the VIX > 17 and rising, otherwise during up-markets it buys either QLD or DDM, or IEF when upmarket conditions are absent.
  • A backtest of the model from Jan-2011 to Jul-2017 produced a high 60% annualized return with a maximum drawdown of -16% with only 41realized trades.

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Profiting from Market Volatility with the “Anti-VIX” ETF SVXY

  • The “Anti-VIX” ETF SVXY is designed to increase in value when the volatility of the S&P 500 decreases, as measured by the prices of VIX futures contracts.
  • Extended data of SVXY, the ProShares Short VIX Short-Term Futures ETF, from Jan-2006 to the fund’s inception date was calculated from its proxy, the S&P 500 VIX Short-Term Futures Index.
  • SVXY is intended for short-term use. Using the extended price data, a buy-and-hold strategy of the hypothetical SVXY resulted in a huge loss of over 90% from 2007 to 2009.
  • The model buys SVXY only during up-markets when the VIX > 17 and rising, otherwise during up-markets it buys either QLD or DDM, or IEF when upmarket conditions are absent.
  • A backtest of the model from Jan-2007 to Jul-2017 produced a high 70% annualized return with a maximum drawdown of -27% with only 76 realized trades.

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The iM-Capital Strength 20-Stock Universe of the Russell 1000: Performance

  • This Universe holds well capitalized companies with strong market positions, which pay good dividends, have price appreciation potential, and provide a degree of downside protection during bear markets.
  • The Universe is reconstituted weekly, and consists of 20 large-cap stocks with Capital Strength type characteristics from the Russell 1000 Index.
  • A backtest, without any buy- and sell-rules, from Jan-2000 to end of Jun-2017 showed a 10.0% annualized return with a maximum drawdown of -41.5%.
  • A comparison with Vanguard’s large-cap ETFs older than 10 years shows that for periods 1-year and longer the Universe would have produced higher returns than any of the five ETFs.

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Beating Vanguard’s Large-Cap ETFs with a Tax Efficient Capital Strength Portfolio of the Russell 1000

  • This system invests in well capitalized companies with strong market positions, which pay good dividends, have price appreciation potential, and provide a degree of downside protection during bear markets.
  • The portfolio is quarterly rebalanced and reconstituted, and consists of six large-cap stocks with Capital Strength type characteristics from the Russell 1000 Index, typically held for at least one year.
  • A backtest, from Jan-2000 to end of Jun-2017, showed a 17.7% annualized return with a maximum drawdown of -23.3% and a low average annual turnover of about 70%.
  • A comparison with Vanguard’s large-cap ETFs older than 10 years shows that for all listed investment periods the Portfolio would have produced higher returns than any of the five ETFs.

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Performance Update of the Best10(VDIGX)-Trader: Trading the Stocks of the Vanguard Dividend Growth Fund – VDIGX

  • The Vanguard Dividend Growth Fund-VDIGX is closed to new investors. Want-to-be investors can possibly do better than the fund by investing only in a few positions of the fund’s holdings.
  • The iM-Best10(VDIGX)-Trader relies on the expertise of the Vanguard’s advisors to make the primary stock selection. VDIGX currently holds 45 large-cap stocks from which the Trader periodically picks its stocks.
  • The Trader invests in the ten highest ranked stocks of VDIGX. This strategy, postulated in 2014, has produced to Jun-2017 a 3-year return of more than double that of VDIGX.
  • The 3-year performance of the Trader was 64.1% versus 28.4% for VDIGX, giving an excess return of 35.7%. Trading frequency was low, with positions held on average for 126 days.

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The iM-Standard 5 ETF Trader (Excludes Leveraged ETFs)

  • This system always holds five ETFs (equity-, fixed income-, short equity-, and Gold-ETFs) selected according to stock market climate and rank.
  • Typically, during good-equity markets it holds equity-ETFs, and during bad-markets fixed income-ETFs and/or short equity-ETFs. Also at times it can hold three gold-ETFs with other ETFs.
  • A one factor ranking system selects five ETFs from a preselected list of 29 ETFs. A simulation from 2000 to 2017 shows a 24% annualized return with a maximum drawdown of -12%.

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