Tactical Asset Allocation
March 3, 2009
To demonstrate the logic and characteristics of the timing system, one can test it on the S&P 500 back to 1900. Figure 1 presents the yearly returns for the S&P 500 and for my timing method on the S&P 500 over the past 108 years. The timing solution improved compounded returns while reducing risk. It was invested in the market approximately 70% of the time, and it made less than one round-trip trade per year.
Figure 1: S&P 500 Total Returns vs. Timing Total Returns (1900-2008)
The timing system achieved these superior results despite under-performing the index in roughly 45% of years since 1900.
Figure 2 (drawn with a logarithmic scale) shows that timing was superior to buy-and-hold over the past century, and that it largely avoided the significant bear markets of the 1930s and 2000s. Timing would not have left the investor completely unscathed by the market crash that heralded the Great Depression, but it would have reduced the drawdown from a catastrophic 83.66% to a more manageable 42.24%.
Figure 2: S&P 500 Total Returns vs. Timing Total Returns (1900-2008)
Viewing the results in more detail, a few features of the timing model become evident. First, a trend-following model will underperform buy-and-hold during a roaring bull market like the US equity markets of the 1990s. The timing model’s ability to add value can only be recognized over the course of an entire business cycle. Similarly, the timing model will not participate in a lengthy and protracted bear market. Using the timing model, an investor would have exited the market in October of 2000 and avoided two of the three consecutive years of losses from 2000-2003. The 44.73% drawdown buy-and-hold investors experienced during that bear market was a substantially milder 16.52% using the timing model.
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