- 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%).
- 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.
- 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.
- 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%).
- 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.
- The average of S&P 500 for December 2021 was 4675 (previous month 4670). This is 2155 points higher than the long-term trend value of 2520.
- The current percentage difference of S&P 500 level relative to the current long-term trend level is 85%, a value not exceeded in the recent past since 2001.
- The Shiller Cyclically Adjusted Price to Earnings Ratio (CAPE) is at a level of 38.4. That is 51% higher than its 35-year moving average (MA35), currently at 25.4.
- The CAPE-MA35 ratio is 1.51, forecasting a 10-year annualized real return of about 3.8%. Should the CAPE-MA35 ratio increase further, then 10-year forward returns will be even lower.
- The historic long-term trend indicates a 10-year forward real annualized return of only 0.2%, and the current condition of overvaluation suggest zero returns by the end of 2028.
- Goldman Sachs reported that only 25 stocks accounted for 58% of the index’s 2021 gains, including reinvested dividends, through Dec-9-2021.
- One can verify the accuracy of this list by ranking the S&P 500 stocks on the factor “Market Capitalization x 1-year Rate-of-Change”, with higher being better.
- Backtesting to Jan-2000 shows that buying the 25 highest ranked stocks every year at the end of December would have approximately matched the performance of SPY over the backtest period.
- However, investing similarly in the 25 highest ranked stocks of the lower two terciles of the ranked S&P 500 would have provided over 3-times the total return of SPY.
- The list of 25 S&P 500 stocks to hold during 2022 is given in Appendix-2, which is expected to provide higher returns to Dec-2022 than the Goldman Sachs list.
- Consumer Sentiment, when expressed as the difference in return of the Consumer Staples- and the Consumer Discretionary sectors, can provide risk-on and risk-off signals for equity investment.
- Also a reasonably reliable risk indicator 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 Consumer Sentiment Timer can be improved by including the value of the CARP in its rules to provide more profitable risk-on and risk-off signals for equity investment.
- From 5/1/1999 to 10/15/2021 the Consumer Sentiment & CARP Timer, when accordingly switching between ETFs SPY and IEF, would have produced 18.5% annualized return with a maximum drawdown of -27%.
- 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%.
- This strategy combines the iM-3 Position SuperCombination Timer and the iM-ModSum/YieldCurve [(SPY-IEF) – GLD] Timer models equally weighted.
- A 2000-2021 backtest shows that this combination strategy would have outperformed the SPDR S&P 500 ETF Trust (SPY), showing an annualized return of 23.9% versus 7.2% and with a maximum drawdown of 15.7% versus 55.2% for SPY, respectively.
- The backtest also shows that this combination would have since 2000 produced only positive calendar year returns and would also have outperformed SPY over each calendar year.
With reference to Section 202(a)(11)(D) of the Investment Advisers Act:
We are Engineers and not Investment Advisers,
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