Back in the beginning of the year ^[1], 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 ^[2].” (He is the Chief Investment Officer of Cambria Investment Management ^[3]).

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.