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In an earlier article, Beyond the Ultimate Death Cross, I showed how an investment strategy for the stock market based on signals from a simple moving-average crossover system - the MAC-system - can produce significantly better returns than buy-and-hold. This system's returns can be further improved by linking it to my bond market model.
The improved investment and asset allocation strategyMy improved MAC-system works as follows, with a buy signal and a sell signal triggering shifts from investment in the stock market to the bond market, and vice versa.
Buy signal for the S&P 500
- A buy signal occurs when the 34-day exponential moving average (EMA) of the S&P 500 becomes greater than 1.001 times the 200-day EMA.
Sell signal for the S&P 500
- A sell signal occurs when the 40-day simple moving average (MA) of the S&P 500 crosses below the 200-day MA.
When a buy signal occurs, the whole investment goes into an S&P 500 index fund, and when a sell signal occurs all the funds are moved from the S&P 500 index fund to a high beta Treasury bond fund low or a low beta GNMA fund as indicated by the Bond Value Ratio (BVR) from my bond market model.
To simulate this strategy over longer periods, I began with $1.00 in a bond fund selected according to the BVR-signals (or a money market account, prior to 1980 when bond funds were not available) on the first day of every year from 1966 to 2010. I then transferred the money to a S&P 500 index fund when the first buy signal from the MAC-system occurred, and continued switching investments according to the MAC-signals. I then calculated the terminal value for each year's $1.00 investment, in all cases through August 31, 2012.
Starting with a dollar during each of the 45 years from 1966 to 2010, one would have invested a total of $45 cumulatively by the end. Summing the 45 terminal values, this strategy would have netted this dollar-per-year investor a sum of $3,905. Following a buy-and-hold (B&H) strategy in the S&P 500, one would have only $868, less than a fourth as much.
Had one made the first investment in January 1990, instead of 1966, one would have invested a total of $21 by now. The sum of the 21 terminal values to August 31, 2012 was $161, versus $55 for the B&H strategy in the S&P 500.
The table below lists the internal rate of return (IRR) for the $1 annual investments obtained from a money market account, the B&H strategy of the S&P 500, and from the improved MAC system. Trading costs were taken into account by applying a slippage rate of 0.25% per investment switch.
The greater an investment's Sharpe ratio, the better its risk-adjusted performance. The higher Sharpe ratio for the improved MAC-system indicates that its superior performance relative to a B&H strategy was achieved with less risk.
The technical timing model described above is simple and rule-based. Its average historic internal rate-of-return of about 15% is approximately double that of a buy-and-hold investment in the S&P. This superior performance, together with a low maximum drawdown of 19% versus 55% for the S&P, makes this a desirable, easy to implement investment strategy. (The MAC signals and Bond Value Ratio are available from my free weekly model updates.)
There is obviously no guarantee that the past performance will prevail into the future, but the MAC system has consistently outperformed buy-and-hold, and, what is more, has done so with considerably less investment risk.
Georg Vrba is a professional engineer who has been a consulting engineer for many years. In his opinion, mathematical models provide better guidance to market direction than financial "experts." He has developed financial models for the stock market, the bond market and the yield curve, all published in Advisor Perspectives. The models are updated weekly. If you are interested to receive theses updates at no cost send email request to firstname.lastname@example.org.