Back in the beginning of the year, I mentioned that Mebane Faber and I were exploring updating his Spring 2007 Journal of Wealth Management paper titled “A Quantitative Approach to Tactical Asset Allocation.” (He is the Chief Investment Officer of Cambria Investment Management).

As we discussed back earlier, Meb reviewed a simple timing model — the 10-month moving average — as a signal to enter and exit various asset classes. He demonstrated a notable performance improvement across all asset classes versus traditional “Buy & Hold” investing.

Given the asymmetrical nature of market tops and bottoms, I thought that we could improve the returns of the 10 month MA sell/buy model by tweaking the re-entry signal. The description of markets as asymmetrical is based on both data and personal experience — tops take longer, seem to be more of a process, and develop over a longer time line, while bottoms tend to be more of a shorter, sharper event.

Asked in a different manner:

Assume an investor exits equity markets at the downward break of the 10 month MA; How do the following re-entry signals compare to using the 10 month MA alone? Are there any other signals worth reviewing to as a re-entry?

This is what we will be testing over the next few weeks:

 

1. TREND

  1. BUY:  Price > 5 Month MA (test 6-7-8)
  2. BUY:  Price > 40 week ma (20/25/30, etc.)

2. REVERSION

  1. BUY: Drawdown > 50%
  2. BUY: Price > 20% from 200 day SMA  (25%?)
  3. BUY: % of NYSE stocks above 200 day MA < 15% (12.5%, 20% ?)

3. VOLATILITY

  1. BUY:  VIX > 50
  2. BUY: When more than 50 of the trailing 90 trading days > 1% moves

4. SENTIMENT

  1. AAII Stock Asset Allocation 25 year mean of a 60% — BUY: Allocation > 15% below mean
  2. AAII Bull/Bear Sentiment Ratio –BUY: < 30%

5. MARKET Returns

  1. BUY: Trailing 3 year returns < 5%
  2. BUY: Monthly Return < -7%
  3. BUY: Annual Return < -10%

6. VALUATION

  1. BUY:  Mkt Cap/GDP ratio falls > 40%
  2. BUY: US Dividend Yield > 3%
  3. BUY Tobins Q: Equity Value/Book Value < 0.6
  4. BUY:  Shiller CAPE < 10

7. ECONOMIC (Data to 1948)

  1. BUY: GDP falls > 2% year-over-year
  2. BUY: Coincident-to-lagging indicator falls 10 points from highs

8. INSIDERS

  1. BUY: Insider buying > 20% of 5 year mean
  2. BUY: C-level insiders (CEO/CFO etc) > 15% 5 year mean

9. EARNINGS

  1. BUY: Earnings < -25% Year-over-year
  2. BUY: Earnings revisions > -9% (negative 9% or worse)

 

Based on some preliminary research, suggestions from friends and colleagues, and a dollop of gut feel, this is what we are going to be back-testing.

I would appreciate any suggestions, comments or ideas on the subject.

Category: Investing, Quantitative

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