Update: I updated the charts and some of the performance results on March 28, 2017. I found and corrected an error in the performance calculations. Conclusions remain the same.
It’s finally time to start turning all the economic indicator stuff I’ve been posting on into something useful for investors. In this post I’ll introduce the SPY-COMP indicator and how it works as tool for entering and exiting investments.
The mechanics of the SPY-COMP system are similar to the SPY-UI system I’ve posted on previously. The only difference is that the new system uses a composite of the top 6 economic indicators instead of only using a single indicator, the unemployment rate. There are many ways to build a composite but we keep it simple. Each indicator covers a different aspect of the economy so we have the composite indicator trigger whenever any one of the 6 indicators triggers. Then, just like the SPY-UI system, the composite triggers the monitoring of the SPY crossing it’s 200 day SMA to signal a buy or a sell signal for investments. Simple. Just like the SPY-UI system but using the COMP indicator.
Now, let’s take a look at some results. Let’s compare buying and holding the SPY to the SPY-UI system and the SPY-COMP system. When the SPY-UI and the SPY-COMP system are out of the market the funds are held in cash (earning 0%) in these simulations. The addition of any kind of bonds only improves the systems’ results. First, we’ll compare drawdowns from 1973 through 2016.
Both the SPY-UI and the SPY-COMP system reduce drawdowns significantly vs the SPY alone. Max monthly drawdown for the SPY during this period was 49% vs 26% for SPY-UI and 16% for SPY-COMP. The biggest difference between SPY-UI and SPY-COMP is that SPY-COMP captures some of the large non-recessionary drawdowns in the SPY. Now, let’s look at total returns. The chart below is a log chart of total returns for each system from 1973 through 2016.
Total annualized returns over this period for the SPY are approximately 10.2%. For SPY-UI total annualized returns are 12.4% and for the SPY-COMP system they are 12.8%. Again, these returns do not include any bond returns for the SPY-UI and SPY-COMP system while they are out of the market. For example, the SPY-COMP system was out of the market from Nov 2007 through May 2009. During that time an investment in intermediate government bonds (IEF) would have returned 14.5%. Over the 1973 to 2016 time period the SPY-UI and the SPY-COMP system were out of the market 16% and 22% of the time respectively.
Note: I say returns are approximate because I had to build my own monthly total return series from the Shiller SP500 data . I assumed dividends for the index were paid out equally over 12 months for all years which is an approximation.
One way to look at these systems is that they are trying to distinguish between volatility to pay attention to and volatility to ignore. And these systems do ignore some significant volatility. Easy for an algorithm. Not so easy for humans. For example, let’s look at the last two years of the SPY-COMP system.
There was no significant weakness in the economic indicators in 2015 and 2016 but there was still some significant volatility with the SPY crossing below it’s 200 day SMA a couple of times and having a max monthly drawdown of about 8%. The system was saying this was volatility to ignore. But of course, it’s never that easy. If you paid attention to daily fluctuations and the financial news the experience was a lot more painful. Max daily drawdown from July 2016 to Feb 2016 was just over 13%. See below.
In this case the SPY-COMP system was signaling the correct information and investors were rewarded for being patient.
That just about does it. The SPY-COMP system improves somewhat on the already powerful SPY-UI system in terms of returns and drawdowns. Now that we have the SPY-COMP system in place we can use it in TAA and quant portfolios to further improve performance in those systems. More on that in future posts. The SPY-COMP system is now the benchmark system I will use going forward to compare with other investment systems. I’ll provide updates to the SPY-COMP system performance every so often. I’ll track the COMP in the top 6 indicator update that I’m doing during the middle of each month.