Macro Musings October 2020
- In this issue, we are introducing our microCAST™ risk model as a complement to MACROCAST™. The microCAST™ model takes a shorter-term focus, looking for weakness in market internals, while MACROCAST™ takes a more holistic view, aimed at identifying recessionary bear markets.
- The past three quarters saw positive performance across various asset classes, with particular strength in international stocks, which were buoyed by a weaker dollar.
- The S&P 500 gained more than 8% in the third quarter. Historically, when Q3 was up by more than 7.5%, the remainder of the year saw positive returns.
While MACROCAST™ measures the attractiveness of risk assets by looking at the VITALS, microCAST™ measures the short-term risk and volatility of the market by looking at TUMS —Trend, Underlying Breadth, Momentum, and Sentiment.
Aggregating the signals across the underlying TUMS indicators, microCAST™’s risk posture is classified into one of five distinct tiers that indicate the model’s recommended exposure to risk assets: most aggressive, aggressive, neutral, defensive, and most defensive. Strategies utilizing the microCAST™ model can quickly add or reduce risk exposure, moving between 100% invested in risk assets to 100% in cash, depending on the level.
There are several key differences between MACROCASTTM and microCAST™:
- While MACROCASTTM measures the risk of a sustained, recessionary bear market, microCAST™ shows general market pressure, regardless of the cause. As a result, microCAST™-based strategies will trade more often.
- In other words, MACROCASTTM seeks to mitigate downside potential in the intermediate-term (6 to 18 months), while microCAST™ focuses on the short-term (1-3 months) downside potential.
- MACROCAST™ tracks a broader range of indicators that consider the strength of the economy and implications of Fed policy; microCAST™ focuses exclusively on technical measures of market internals.
- MACROCAST™ accepts and rides out the smaller, intermediate-term drawdowns that regularly occur over the course of a bull market, recognizing the fact that outside of a recession, the market generally resolves higher; whereas, microCAST™ aims to reduce volatility by acting on what the market is doing and not what it’s expected to do.
- microCAST™ is best suited for the risk-averse and drawdown sensitive, seeking to minimize short-term volatility.
A CASE STUDY: Q4 2018
The best way to explain this multi-pronged approach is through an example. In the fourth quarter of 2018, the stock market sold off 20% from peak to trough, driven by concerns of a slowing global economy and a Federal Reserve that was determined to keep raising interest rates.
During this time, MACROCAST™ never went negative. The model indicated that this was a slowdown during an economic expansion, similar to 2011 and 2015-16, and not the start of a new recession.
However, despite our conviction, the volatility was jarring, particularly in December 2018 when the S&P 500 dropped over 15% from the start of the month into Christmas Eve.
While MACROCAST™correctly forecast the drawdown would be temporary and remained fully risk on, the indicators we use to track microCAST™ would have been more aggressive in reducing risk, thereby, potentially reducing the overall drawdowns for any account using the microCAST™ filter. Note that this does not mean that microCAST™ strategies would have seen better overall returns during this period, just that they would not have remained fully invested during this episode of market volatility.
What is microCAST™ SAYING now?
After a September market correction that saw microCAST™ shift to neutral, the current signal is most aggressive, which implies being 100% invested in risk assets. Despite the expected volatility around election season, the market is acting well.
ASSET CLASS REVIEW THROUGH Q3: A STRONG QUARTER FOR RISK ASSETS
The below table highlights the performance of major asset classes through September 30th:
Source: Charles Schwab
Reviewing asset class performance in the third quarter and year to date, the most interesting takeaways are:
- Every major asset class generated positive returns. From stocks to bonds to precious metals, Q3 saw positive returns across the board.
- International stocks topped the leaderboard, thanks in part to a weaker US Dollar. The best performing asset classes were international small cap and emerging market stocks. Those categories tend to outperform US equities when the dollar weakens, and last quarter, the dollar was lower by 4% versus other major currencies.
- Bonds are still outperforming stocks year to date. Despite the big rally in stocks since the end of March, most bond categories are outperforming stocks in 2020. Bonds remain a valuable diversifier, even in a low interest rate environment.
BIG GAINS IN Q3 LED TO BIG GAINS IN Q4
The S&P 500 was up 8.5% in the third quarter (8.9% including dividends). Historically, strength beget strength. Historically, when Q3 performance was up at least 7.5%, it led to Q4 gains every time (table from LPL):
Only two of those years were presidential election years (1980 and 1984), and while 1980 was up over 8%, the market was essentially flat in 1984, rising just under 1%.
In case you missed it…
The latest episode of the Corbett Road Podcast was published last week. We discuss historical stock market performance around election season, as well as the continued economic recovery.
The Corbett Road Podcast is available on all major podcasting platforms, including Apple, Google, and Spotify. Search “Corbett Road Podcast” and hit Subscribe to get the latest episode as soon as it’s released. You can also listen to it on our website at https://wealth.corbettroad.com/podcasts.
A LOOK AHEAD: OUTLOOK 2021
We will publish our next edition of Macro Musings in early December, which will cover our firm’s initial thoughts on the year ahead. I believe we can speak for most of our clients and partners in saying, here’s hoping that 2021 will be a less eventful year.
Thank you for reading our latest thoughts and analyses. We appreciate any feedback and value your continued relationship and trust.
The chart(s)/graph(s) shown is(are) for informational purposes only and should not be considered as a suggestion of any investment recommendation, investment strategy, or as an offer of advice to buy, sell, or exchange any investment product or investment vehicle. Past performance may not be indicative of future results. While the sources of information, including any forward-looking statements and estimates, included in this (these) chart(s)/graph(s) was deemed reliable, Corbett Road Capital Management, LLC does not do not guarantee its accuracy.
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions of Corbett Road Capital Management, LLC.
All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. MACROCASTTM is a proprietary index used by Corbett Road Capital Management to help assist in the investment decision-making process. Neither the information provided by MACROCASTTM nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. The phrase “the market” refers to the S&P 500 Total Return Index unless otherwise stated. The phrase “risk assets” refers to equities, REITs, high yield bonds, and other high volatility securities. Past performance is no guarantee of future results.
Corbett Road Capital Management, LLC is a Federally Registered Investment Advisory Firm.