Combining Vol, Economic, Trend, and Momentum Strategies

[pmward]

On economic signals...I use a combination of various macro data series and an old fashioned monthly moving average.

The code for the signal is: IIf(MacroEconSig >= 0, 1, IIf(MacroEconSig < 0 AND C > MA(C,6), 1, -1));

In English:

If the MacroEcon signal is >=0 then = 1
If the MacroEcon signal is < 0 then check to see if the monthly close is above the 6 month moving average if it is then also =1. If not, then -1.

1 is long, -1 is flat. Since 1/1/2008 the CAGR is 15 and the MDD is -20

I use 7 different macro econ series that are either +1 or -1 at all times.

That sounds very much like SpyComp. He uses the 7 economic signals I mentioned above. Only instead of a sum if all are green it does nothing, if any is red it defers to trend. I will also say 6 month SMA is a nice sweet spot for trend. It backtests better than the 200 day SMA that GTT uses.

[pmward]

Readings on dual momentum...read both the original and the rebuttal

Original: https://blog.thinknewfound.com/2019/01/ ... entum-gem/

Rebuttal: https://dualmomentum.net/2019/01/17/whi ... entum-gem/

You will learn a TON by reading these two articles. I was persuaded by the original and made adjustments to my approach accordingly. In practice what I have found using segmented momentum ranging from 3-12 months is that transitions between assets are no longer binary. It's more gradual in and out and the way I do it I can be holding 1-3 of the assets at the same time. Sticking with classic dual momentum is much easier to execute. What I do requires programming and data to pull off.

Ok I read through the articles. Yes those were really good articles. I remember watching Ocho despair here back in Q4 2018 when GEM fell apart. This is part of why I never really considered GEM, even before Q4 2018 it just seemed too fragile to me. It's not the actual dual momentum piece between US and Intl that is the issue, that performs just fine. It's the "risk-on/risk-off" comparison of the S&P to T-Bills, as well as the only 1x per month trading that leaves a big window open for bad things to happen. I would never run a quant strategy that did not have some form of a daily risk-on/risk-off signal. This I think is where the vol curve shines, being that daily signal to get you out when the market is crashing at the beginning or middle of the month. The monthly economic and trend signal from SpyComp is just a backup in case vol fails. It makes for a much less fragile and much more robust system than GEM. You really have to fool 2 systems here in order to sit through a crash and sell a market bottom like GEM did in Q4 2018.

Putting the risk-on/risk-off part aside. If we actually look at momentum as it is in my portfolio, just from an alpha generation add-on you get some interesting results.

Doing just vanilla DM since 1998 (For reference SPY alone was 7.37% CAGR)
10 month: 7.99% CAGR https://www.portfoliovisualizer.com/tes ... odWeight=0
12 month: 7.2% CAGR https://www.portfoliovisualizer.com/tes ... odWeight=0
Average 3, 6, and 12 month: 8.32% CAGR https://www.portfoliovisualizer.com/tes ... odWeight=0

So doing the average of 3, 6, and 12 actually out performed both of the single periods. I also think fundamentally it's more robust. Other ways one can diversify to make this more robust? Well lets use that 3, 6, 12 and add some extra stuff in. So we start with the benchmark of US/Intl dual-momentum, since 1998 with 8.32% CAGR and 27 total trades in that timeframe.

Tri-Momentum, pick 1 US/Intl/EM: 10.59% CAGR with 48 total trades. So significantly more trades, about 2 trades per year average, but much higher CAGR. https://www.portfoliovisualizer.com/tes ... odWeight=0

Ok, so what if we want to make this even more robust by adding in some diversification? Like holding only 1 thing is easy, but it is admittedly fragile. You're all in on one thing.

IJH, IJR, IVV, QQQ, VTMGX, VGSIX, VIVAX VEIEX, IEF, GLD, FXI pick top 4: since 2006 11.02% CAGR 117 total trades: https://www.portfoliovisualizer.com/tes ... odWeight=0

Now to be fair, not every one of those 117 trades is a full 100% portfolio turnover like it is in the other ones. We are doing pick top 4, so each of those trades is at least 25%, at most 100%. We also have a bunch of added diversification to the tri-momentum including gold, tech, bonds, real estate, mid caps, small caps, china, etc. The benefit here is that we have diversity in 4 picks each month, so if #1 underperforms but #4 out performs, it helps balance things out.

So basically, we started with single time period look backs, then went to multiple time period look backs averaged out to eliminate anomalies. Then we added in emerging markets to add a bit more diversification. Then if we want further robustness and diversification, we can take that and do a top x across a diverse basket of assets. Each step reduces fragility, adds diversification, and improved returns. Now, you take something like the tri-momentum or the take top 4 momentum and you add the vol curve and SPYComp (or GTT Trend) on top, and boom you got a 19-20% CAGR portfolio. Then add in leverage to you reach your desired risk/return flavor. There's so much that can be done in the momentum layer to improve return, diversity, and robustness.

[Kbg]

There is much that can help with diversity. You may want to go checkout the GAA link I posted as there is a lot of diversity in terms of approaches.

One caveat and caution, the thing I have really come to appreciate is simplicity. The more moving parts the less assurance that there is any “there” there. Unfortunately I have learned that lesson in the school of hard knocks.

I’ll look into spycomp next.

[pmward]

There is much that can help with diversity. You may want to go checkout the GAA link I posted as there is a lot of diversity in terms of approaches.

One caveat and caution, the thing I have really come to appreciate is simplicity. The more moving parts the less assurance that there is any “there” there. Unfortunately I have learned that lesson in the school of hard knocks.

I’ll look into spycomp next.

Agreed. Yeah there is a point where you reach adding complexity for the sake of complexity. I wouldn't necessarily recommend the "take top 4" portfolio to everyone. It would depend on what they want. I personally tend to prefer a bit more concentration in my momentum, but some people are turned off by that. I totally missed the GAA post, I popped it in a new table and I'll read through that tomorrow.

[pmward]

Here is an old blogpost for the 6 indicators included in v1 of SpyComp https://investingforaliving.us/top-6-ec ... ndicators/

That's "good enough" for any DIY investors. On the paid service he uses a v2, from which they built a recession probability model to tweak the indicators to be more accurate in identifying the start and end of recessions. Still very similar indicators to v1, but he has not actually given the signals even to paid subscribers for the v2 signals. I'm still following along and trying to figure out what he is doing there.

[pmward]

Another article worth looking at is this. Back in Jan it was a post ranking the performance by various metrics going back to 1973 of SpyComp against other popular strategies, including popular buy and hold (including the PP and Robbins "all-seasons") and TAA strategies (including some you linked in that TrendXplorer post yesterday). https://investingforaliving.us/2020/01/ ... 3-to-2019/

That DM-Comp (dual momentum SpyComp) holds up pretty well (17.27% CAGR over 47 years). This obviously doesn't include the vol curve either, which would increase returns.

[InsuranceGuy]

[deleted]

[pmward]

On economic signals...I use a combination of various macro data series and an old fashioned monthly moving average.

The code for the signal is: IIf(MacroEconSig >= 0, 1, IIf(MacroEconSig < 0 AND C > MA(C,6), 1, -1));

In English:

If the MacroEcon signal is >=0 then = 1
If the MacroEcon signal is < 0 then check to see if the monthly close is above the 6 month moving average if it is then also =1. If not, then -1.

1 is long, -1 is flat. Since 1/1/2008 the CAGR is 15 and the MDD is -20

I use 7 different macro econ series that are either +1 or -1 at all times.

That sounds very much like SpyComp. He uses the 7 economic signals I mentioned above. Only instead of a sum if all are green it does nothing, if any is red it defers to trend. I will also say 6 month SMA is a nice sweet spot for trend. It backtests better than the 200 day SMA that GTT uses.

Have you both tested Breadth Momentum (VAA) or a Canary Universe (DAA) in addition to or instead of using Economic models? I share some of Kbg's concerns in an earlier post about timing of releases and updates to prior releases in future releases of data.

I find that using crash protection from a fairly broad universe such as: S&P 500, REIT, Emerging Markets, Developed International, and Aggregate Bonds seems to give better results than any combination of economic factors including UE or GTT.

Paul has an article on the pay site that goes into the topic of economic revisions specifically, and why he believes that the hubbub about revisions is not really that big of a deal. He compared the FRED to the ALFRED databases (ALFRED stores the full audit log of all revisions, while FRED only stores the most recent update) to see how it backtested with the original signals instead of revised signals. Basically, it didn't make a real statistical difference in the end result of SpyComp results, which include data from the last 6 total recessions. Also, he lists a bunch of reasons why one indicator flashing a little early or late wouldn't make that big of a difference:

1) there is a double trigger, you need to both have economic data go red AND a trend following signal go red. Just a false economic red alone does not cause one to sell stocks.

2) In all past recessionary times multiple of the 7 signals triggered red in the month or two prior to the stock market peaking (and in turn prior to the trend following signal going red). So one false positive or negative wouldn't make a difference.

3) Before a real recession (what the model is designed to avoid) the signals tend to not just dip into the red, they go RED if you catch my drift. Like, there is no revision that could really change anything.

4) Around a recession being a month or two late or early tends to not really make that much of a difference in the grand scheme. See the results of this Goldman study going back to the 1960s about trading the exact peak month vs being 1-3 months early or late, really not much difference:

Screen Shot 2020-12-05 at 8.33.04 AM.png (1.7 MiB) Viewed 5532 times

That being said I have not tested VAA or DAA. I would be interested in looking more into them. This article here has comparisons of different TAA and buy and hold models. VAA is on it, but not DAA. Over the full time frame it performed a bit better than SpyComp, but was a bit more risky. Also, VAA looks to have performed like crap over the last 10 years, and performed inline over the last 20 years, so most of it's out performance was from 20+ years ago. https://investingforaliving.us/2020/01/ ... 3-to-2019/

It also would be remiss to not mention that we also have the volcurve in this model. If either goes red you go into crash protection. The odds of catastrophically fooling the vol markets, economic data, and trend following signals are incredibly low. Not impossible, nothing is impossible, but very unlikely.

[InsuranceGuy]

[deleted]

[pmward]

A couple of comments:

1) I've read Pauls article about revisions, my apprehensions go further. I will admit my bias which seems to be backed by my prior testing that economic is only causal inasmuch as markets react to that data.

I agree, the markets very rarely react to fundamentals. The time periods they do react to them are maybe 5% of the time at most... but when they do it is always reacting to the downside, haha. That's the point of the double trigger though. The economic data doesn't create a red risk-off condition, it just is used as a yellow warning sign. When the economic data is bad, it then goes to the trend following component to look at what the market is actually doing. Mind you, I don't think I would do 100% SpyComp without the VolCurve for a number of reasons... economic data limitations being one, but the biggest limitation is I just don't think monthly only signals react quick enough. I think there needs to be some form of a daily signal to get out of the way of a crash like 2020 or 1987. I do like what I see when I look at the combination of the VolCurve and SpyComp together. Both systems have their strengths and weaknesses (like any model does) and combining both helps to hedge the weaknesses, especially when using leverage.

2) Again, my question is have you considered skipping the economic data and considering the interaction of multiple markets such as large/small cap, domestic/foreign, real estate, developed/emerging, treasuries, gold, etc? I agree with the premise that economic data is only acted on by the models when markets react to it, my assertion is that skipping economic data and monitoring when multiple markets retreat, treasury yields tank, or gold strengthens gives more info as it represents the market reaction to the data.

I'm totally open to combining the volcurve with other models. I wish kbg had not left the forum, as in private chat I had him run some backtesting on the quant software he uses, and it would have been nice to see how some other models ran substituted in for the SpyComp portion. Now one could certainly include all those factors and assets you mentioned in the risk on "momentum" layer I mentioned. That way in periods where gold, or bonds, or small cap, or whatever is out performing you will tilt towards that in risk-on. Matter of fact if you look back a ways at my post on momentum I showed a "pick top 4" model that included all the above and performed really well.

Do you have any existing systems you're aware of that do something with this inter-market data as a risk-off/risk-on trigger that I could take a look at? It would be helpful for me to see something in practice as a base.

3) I like the idea of using the volcurve, but the historical data is limited to the past 15 years or so. I have a preference towards backtesting back to al least the early 70s to test a rising interest rate environment.

Yeah, ideally it would go back further. But that's the nature of the beast sometimes. I think the VolCurve has a solid enough fundamental reasoning behind it that it is forgivable to stick with the data we have available. Especially since these days volatility and the options markets have such an outsized effect on the stock market. Volatility and options really didn't have any effect whatsoever back in the 70s for instance.

4) I wasn't asking about the VAA or DAA models in their entirety as they clearly have underperformed during the past 10 years, my question is around the crash protection schemes implemented in both (Breadth Momentum and a Canary Universe) in addition to or instead of using Economic models?

Yeah I understood. Hopefully kbg will come back and I could have him run these, I do not currently have software that can easily mock this up. All of my testing is by hand in Excel... it's a very... time consuming task, haha. I also used Paul a bit when I was first contemplating using this strategy and I was signed up for his QuantPulse newsletter. I had him try a few ideas I had, but outside of improving the momentum layer beyond just DM I was not able to come up with anything that outperformed the base model. Are you aware of any websites that have the dates of all past trades listed for VAA and DAA? That would make it quite a bit easier for me to play with the data in Excel. Also, I have not looked super close into either VAA or DAA, just read a very brief description. Do you have any articles you would recommend that go in depth into those strategies?

5) It was interesting to see Pauls comparison of TAA strategies back in January as my own variant (which uses very similar principles to those in this thread) seems to crush most of those portfolios. I do not use any economic data because as hard as I tried to get it to work market price data worked better in every iteration. Here are the comparable stats (1973-2019) for my variant (which can be found in a separate thread):
CAGR 21.0% / StDev 14.7% / Best Year +65.3% / Worst Year -7.0% / Sharpe 1.43 / Last 20 Yrs 15.0% / Last 10 Yrs 15.2%

I'll also have to dig into your thread. I'm about to head out the door, but maybe this afternoon I'll get some time to dig in and see what you're doing. What is your max daily drawdown? Is that levered or unlevered?

[InsuranceGuy]

[deleted]

[ochotona]

2020 was a great year for me. I had a combination of moving-average based trendfollowing, and Paul Novell's volatility-based trading, and buy and gold bonds, gold, cash and some stocks... I was up 17% with a 3.5% or so March 2020 drawdown. Exactly as intended... same drawdown and pain factors as the HBPP, but more upside. If this continues, I'm looking at early retirement. My retirement plan was designed to function at 5% CAGR. 17% changes things a great deal.

In 2020 I bought Bitcoin at a decent price. It has DOUBLED. At some point I'll pull my initial capital out (as a long-term capital gain) and just watch, come what may.

I'm into a bunch of Junior miners recommended by TheDailyGold.com. They've been really solid performers as a group. Much better than GDX, GDXJ, or the underlying metal. This service has paid for itself many times over in just two months.

GPM-COMP, a model by Paul Novell based on GPM 53%
Other Tactical Asset Allocation (TAA) models by Paul Novell, mostly Volatility Based 13%
Buy & Hold Equities 1% (EM Value)
Bitcoin 2%
Gold 10%
Silver 1%
Junior Gold miners picked by Jordan Roy-Bryne, also Newmont, Barrick, and SLVP Silver Miner's ETF 4%
Cash & Cash Equivalents 13%
Bonds 3%