The Meta Strategy ETF Portfolio Newsletter – 09 2020

The Meta Strategy ETF Portfolio
monthly issue #21, September 2020

Dear Subscriber,

the year 2020 will go down in history as one of the strangest ever – in markets as well as in real life.

While the economy is recovering from extremely depressed levels and is still facing severe headwinds in the ongoing pandemic, the stock market shoots up in the fastest recovery to new all-time-highs in US history. Meanwhile we see data indicating increased risk because of excessive speculation and market anomalies that have surpassed even the records of the year 2000. 
This has materialized last week in a very quick sell-off, that is likely to continue for a while longer.

The Meta Strategy indicators signaled the change to a bull market regime on July 10th while fundamental economic improvement is still lagging behind. The current correction is overdue, normal and a long way from triggering an exit from the stock market. On the contrary, I will now use the pullback to switch the equity allocation in the aggressive portfolio from a regular to a leveraged S&P 500 ETF as the long-term outlook continues to be positive.

Our gold position took a well deserved breather last month and the portfolio was carried by gains in the S&P 500 – the market drop over the last two days pushed this month’s performance down to end 1% in the green. 

As long as fundamentals are not showing a green light, I will keep half of my portfolio in gold to diversify my portfolio. Often gold performs as well as stocks in the early stages after severe economic troubles and the asset will keep us diversified should the economy run into unanticipated problems.

All the best to you!

sincerely

David Steets

You can find all recent editions in the Member Area or the pre-04-2020 newsletter archive, including a FAQ section, here.


Portfolio changes

Defensive ETF portfoliono changes
Aggressive ETF portfolioswitch 50% to 2x leveraged S&P 500 ETF; hold 50% Gold ETF

Background

The Meta Strategy uses systematic fundamental and technical inputs to gradually rotate a portfolio between different asset classes according to market conditions. It is invested in stocks by default, because they return more than other financial assets (for example bonds, real estate or commodities) over the long term. A traffic light model, that judges the health of the economy and the stock market, determines how much of the portfolio is allocated to these risky assets and when to move to safe or alternative assets to protect against the risk of losses.

Find out more details about the Meta Strategy here (oder hier auf deutsch). 
I run two model portfolios suited either for normal or more aggressive investors. Both portfolios use the same signals, but invest in different exchange traded funds (ETF) that cover broad markets. 

Defensive ETF portfolio characteristicslong only
Aggressive ETF portfolio characteristicsleveraged long and short

The defensive portfolio aims to earn the same return as the stock market, but with only half the maximum losses from the peaks over the long term.
The aggressive portfolio, for investors who can stomach the risk of drawdowns as high as we have seen in the stock market in the past as well as higher short-term fluctuations, aims for returns that beat the stock market over the long term. 
Using leveraged ETF will magnify the daily move of the underlying index by the leverage factor. Short (or inverse) ETF will return the opposite of the index every day – this causes a rise in the value of the fund in a falling market and allows us to profit in prolonged bear markets.

Scroll down to the bottom of the newsletter to see the returns of the model portfolios since inception and a historical performance backtest.


Current indicator status


What does the current market environment tell us?

Fundamental indicatorsRED warning since April 2020
Technical indicatorsGreen light for re-entry into stocks on July 10th.

Systematic indicators based on the price of the the US stock market and the state of the US economy, as the dominant driver of asset prices worldwide, define my assessment of the market environment. See here for detailed rules on how these indicators are used to generate the current status.


Thoughts on the market environment

While the economy recovered from extremely depressed levels and is still facing severe headwinds in the ongoing pandemic, the stock market shot up in the fastest recovery to new all-time-highs in US history. Meanwhile new data indicated increased risk because of excessive speculation and market anomalies that surpassed even the records of the year 2000. 

Signs in market volatility (VIX becoming correlated with the S&P 500) and options (extreme call buying in select tech stocks was a major factor squeezing markets up) were showing ever increasing risks throughout the month. 

Additional problems where showing up under the hood as fewer and fewer stocks carried the S&P 500 to new highs over the last weeks.

This lack of breadth and a speculative squeeze leading to an upwards „crash“ was followed last week by a sell-off, that was just as quick. The correction was widely expected, but extremely difficult to time and is likely to make for a continued rocky September / October.

The Meta Strategy, however, signaled a regime switch to a new bull market environment. This signifies a high probability for the bull case scenario to continue a while longer. We can tolerate a short correction and patiently wait for the next systematic exit signal from stocks. Whenever it may come, probabilities are that it will be at higher prices than our entry – even if we shouldn’t expect the relentless rally of the last months to continue indefinitely.

A closer analysis of long-term factors shows a positive picture over the next 6 to 18 months:

  • Momentum is positive whichever way you look at it and is supported by record highs in international economic recovery surprises. 
  • The flight to safety, that led to record high inflows into money market funds, is now reversing and ensures continuing demand for equities.
  • ISM manufacturing PMI cycled from contraction back to expansion this month which has led to solid long term returns historically.

Overall we do not really have to make decisions considering these factors, because the Meta Strategy will systematically tell us what to do. I choose to implement the strategy in a conservative fashion within its rules and spread the rotation from gold into equities over some time to stay more diversified. Gold has a high relative strength over the last months and as long as that persists it is a promising asset to hold in challenging times for the economy.

The Meta Strategy signals

The strategy’s technical indicators signaled a return to a bull market regime. The S&P 500 has held above its long-term trend (275-day moving average). Volatility is still elevated, but the danger signal – the VIX futures term structure – stays positive.

While fundamental indicators still mirror bad economic conditions (the model signals a red light), most of the data is showing distinct improvement from the deepest lows. It is normal for the economy to lag the stock market coming out of a recession.

Agressive Portfolio

The simplest way to switch from a regular to a leveraged equity ETF is to simply sell one and buy the other at the same time.
However, I will personally chance some short term market timing and use a specific short term trade setup to time the switch roughly as follows (more details and updates in my September 7th premium report):

  • Sell the regular ETF on a bounce of roughly half the initial drop in the current pullback.
  • Buy the leveraged ETF in the area between the initial correction low and the 60-day moving average.

This requires active monitoring of the market and may lead to a better result, but it may also miss the re-entry (I will then enter at the next pullback to the 60-day moving average which may be at higher prices).

Here you can find acomprehensive list of fundamental and technical indicators used in the Meta Strategy model, including a list showing their warning signal triggers.


Current asset class selection

Asset ClassPortfolio allocation
Risky assets: stocks50%
Safe assets: bonds0%
Alternative assets: gold50%
Cash0%
Aggressive assets: short stocks0%

Why did I select these asset classes?

The Meta Strategy signaled a re-entry into equities on July 10th 2020 – its default positioning.
Gold remains the preferred alternative asset, because it shows a strong up-trend and great value in current conditions. As long as its relative strength persists I will stay diversified between these two asset classes.

Find the systematic rules governing the asset allocation in the model portfolios here.


Current portfolio

Defensive ETF portfolio50% Gold & 50% S&P 500 ETF
Aggressive ETF portfolio50% Gold & 50% 2x leveraged S&P 500 ETF

List of ETF

Current regulations prohibit Eurozone investors from buying US based exchange traded funds (ETF), but they can choose EU equivalents. Several choices are usually available and I only list one possibility here. Best practice is to select the cheapest, most liquid ETF available. 

US ETF S&P 500: SPY or
2x S&P 500: SSO
Inverse/short S&P 500: SH
Euro STOXX 50: FEZ
2x Euro STOXX 50: FFEU
Gold: GLD
EU ETF S&P 500: iShares Core S&P 500, IUSA, ISIN IE0031442068
2x S&P 500: Xtrackers S&P 500 2x Leveraged Daily Swap, DBPG; ISIN LU0411078552 
Inverse/short S&P 500: Xtrackers S&P 500 Inverse Daily Swap, DXS3, ISIN LU0322251520
Euro STOXX 50: Invesco Markets plc-EURO STOXX 50, SC0D, ISIN IE00B60SWX25
2x Euro STOXX 50: Lyxor EURO STOXX 50 Daily (2x) Leveraged, LVE, ISIN FR0010468983
Gold: iShares Physical Gold ETC, PPFB, ISIN IE00B4ND3602

Portfolio performance

Monthly returns of the two model portfolios are tracked in real time since January 2019 (this is not a backtest). I invest my own money in the aggressive ETF portfolio.

Portfolio performance assumes no commissions which is realistic for some US discount brokers. Transaction costs are higher at EU brokers and traditional banks.

The model portfolios are not currency hedged. I use US ETF to track performance in US$. Depending on the investor´s location currency fluctuations have an impact, that tends to equal out over time. 


Using the Meta Strategy framework with different trading strategies

The Meta Strategy framework is very versatile and can be used to allocate capital to individual trading strategies rather than only invest in broad market index ETF – this has the potential to enhance performance or to hedge some of the portfolio volatility.

Meta Strategy Derivatives Portfolio

This holistic investment and trading portfolio, that combines the Meta Strategy Aggressive ETF Portfolio with a trading strategy using derivatives (e.g. options or futures), is now available as a premium subscription. I describe the ideas behind a Probability Map for future returns of the S&P 500, which drives the trading decisions in the Meta Strategy Derivatives Portfolio, in this article and you can see what the weekly report looks like here.

Recent key market insights

Current market studies across different influential factors and time-frames point to very similar conclusions: 

  • Short-term bearish
  • Medium-term neutral
  • Long-term bullish

We are in a bull market regime – the most profitable, „normal“ environment we see about 75% of the time, albeit still in a state of high volatility.

Opposing study results across different time frames effectively lead to a neutral outlook over the next few weeks.
Rising correlation between VIX and the S&P 500 tipped the scale for last week’s probability outlook to be short-term negative. 

I expressed this view by going into the pullback slightly net short (one half of the short position was right on time showing a good profit, while a covered call hedging the long-term SPY position was early and is still trading at a slight loss).
I now plan to follow the pullback on the short side with a short-term trading setup (in Monday’s new report) to then slowly switch to leveraged long exposure including some explicit short volatility positions at pre-defined target areas below today’s index level.


The most likely scenario is a continuation of the overdue pullback followed by higher prices. The first sharp correction in the new regime now makes for a great long-entry opportunity.

Good opportunities can often be found elsewhere while US equity return forecasts are neutral. A section on asymmetric trades in my weekly report broadens the investment universe with additional ideas.

The working thesis is, that we are in a speculative environment which is now supported by a bullish long-term market trend. Strong momentum often holds for considerable time before turning around violently.

This has played out in agricultural commodities over the past weeks and a recent option trade managed to catch a strong move in Corn for a 120% gain.

The strategy is now updated in the weekly Meta Strategy Derivatives Portfolio – Probability Map update (premium subscription).

Back to some additional information on the Meta Strategy ETF portfolios:

Position history

Date Defensive PortfolioAggressive Portfolio
06.01.19 cash cash
06.02.19 cash cash
06.03.19bonds, goldbonds, gold
06.04.19US stocks, gold2x leveraged US stocks, gold
06.05.19US stocks, EU stocks2x leveraged US stocks, 2x leveraged EU stocks
06.06.19US stocks, EU stocks2x leveraged US stocks, 2x leveraged EU stocks
06.07.19US stocks, EU stocks2x leveraged US stocks, 2x leveraged EU stocks
06.08.19US stocks, EU stocks2x leveraged US stocks, 2x leveraged EU stocks
06.09.19US stocks, EU stocks2x leveraged US stocks, 2x leveraged EU stocks
06.10.19US stocks, EU stocks2x leveraged US stocks, 2x leveraged EU stocks
06.11.19US stocks, EU stocks2x leveraged US stocks, 2x leveraged EU stocks
06.12.19US stocks, EU stocks2x leveraged US stocks, 2x leveraged EU stocks
06.01.20US stocks, EU stocks2x leveraged US stocks, 2x leveraged EU stocks
06.02.20US stocks, EU stocks2x leveraged US stocks, 2x leveraged EU stocks
04.03.2050% US & EU stocksUS stocks, EU stocks
10.03.20cashcash
05.04.20cashcash
05.05.20goldgold, short US stocks
05.06.20goldgold, short US stocks
05.07.20goldgold, short US stocks
13.07.20goldgold, cash
05.08.20gold, US stocksgold, US stocks
05.09.20gold, US stocksgold, 2x leveraged US stocks

Historical performance backtest

A 15-year backtest, followed by one year of actual investment performance, (06-2003 to 10-2019) of the Meta Strategy Defensive (red) and Aggressive (blue) ETF Portfolios shows the advantages over buy-and-hold portfolios distinctly: Losses in the worst bear markets were reduced, while overall returns were improved in the defensive ETF portfolio. Throughout the backtest the defensive strategy earned about 1% more annually than an investment in the S&P 500 (grey) and the ride was a lot smoother, avoiding the sleepless nights of 2008/09.

These lower drawdowns make a responsible use of leveraged and inverse ETF possible. The aggressive strategy (blue) more than doubled the annual return of an investment in the S&P 500 in the backtest with fewer than two allocation changes per year on average – 16,70% vs 6,73% annually leading to 3,6x more money earned over the 15 year backtest period (not including dividends or transaction costs). 
For comparison I included the performance of a buy and hold investment in a 2x leveraged S&P 500 ETF (green). Here the lethal volatility of untamed leverage becomes apparent: an 83% drawdown in 2008/09, but an outperformance over the S&P 500 over the whole backtest period nonetheless.

Investors seeking a different return / risk profile from the model portfolios can simply mix them with a safe, short-duration treasury bond ETF. For example, the Meta Strategy Defensive ETF portfolio can be expected to lose around 25% from its highs occasionally (in extreme circumstances, e.g. the crash of 1987, losses might even be worse) – half the maximum drawdown of the stock market. Investing only half of the available capital in the portfolio will bring the maximum drawdown down to around -12,5%, but can be expected to yield only half the return of the stock market. The same principle works to dilute the Meta Strategy Aggressive ETF portfolio to yield returns and drawdowns between the defensive and the aggressive portfolios.

Backtested results are hypothetical and NOT an indicator of future performance.


Disclaimer

This letter is a description of my own investment approach and ideas and I personally invest in the aggressive ETF and derivatives portfolio. The content of this letter is for entertainment purposes only and not meant to be investment advice to others.

I am not an investment advisor and I do not provide individual investment advice. None of the ideas in this letter are meant to be construed as professional financial advice.

Your investment decisions are solely your own responsibility and I am not legally or financially responsible for any losses you may incur from reading or using the content on this letter.

Authors may or may not have positions in the securities or related securities mentioned in this blog and newsletters.

All backtested results are hypothetical and NOT an indicator of future performance.

© 2020 David Steets, all rights reserved

David Steets holds the international copyright to all content in this newsletter, any kind of usage of texts and images permitted only with prior written consent by David Steets.

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