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The Meta Strategy ETF Portfolio
monthly issue #24, December 2020
This issue marks the two-year anniversary of the Meta Strategy Newsletter, and I hope you continue to enjoy the monthly read!
We are living through turbulent times, and our investment strategy managed to show its merits this year. It worked especially well in the form of a simple, defensive ETF portfolio, performing in-line with the S&P 500, while enduring much lower levels of drawdown and volatility. This was exactly what I aimed for when constructing the model.
If we consider the alternative scenario of a much worse, prolonged bear market than actually occurred (which was a strong possibility after March 2020), we were very well protected from any losses, no matter how bad things might have gotten. This is not to be underestimated, as many behavioral investment mistakes are made in distressing times, which causes significant underperformance for the average individual investor.
Being out of the market during the March crash helped us to sleep better at night and to stay the course in an unprecedented market environment.
For the aggressive ETF portfolio, the extreme V-shaped bear market of 2020 constituted a “worst case” test. The strategy performed well during into the February/March crash, as it managed to keep losses below the drawdown of the S&P 500, despite using 2x leverage. Coming out of the crash, an incredible rally hurt performance, however, because the aggressive strategy is designed to short the market under certain bear market conditions.
This underperformance can be expected to be more than compensated for in bull market conditions — in fact, if we consider the strong performance in 2019, the overall returns for the two portfolios during the past two years are getting closer already. The updated backtest (which appears at the end of this letter) adds the real returns for the last two years to a longer time period, revealing that a tolerance for such occasional underperformance and higher volatility is likely to be rewarded with vastly higher returns.
Current strong end-of-year tendencies bode well for the next couple of months in this regard.
I wish you all the best, and good investing!
|Defensive ETF portfolio||no changes|
|Aggressive ETF portfolio||no changes|
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, which 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 to either for normal or more aggressive investors. Both portfolios use the same signals, but invest in different exchange traded funds (ETFs) covering broad markets.
|Defensive ETF portfolio characteristics||long only|
|Aggressive ETF portfolio characteristics||leveraged 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 aims for returns that beat the stock market over the long term. It is meant 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.
Using leveraged ETFs will magnify the daily move of the underlying index by the leverage factor. Short (or inverse) ETFs will return the opposite of the index every day, generating profits during a falling market.
Scroll down to the bottom of the newsletter to see the returns of the model portfolios since inception, as well as an historical performance backtest.
Current indicator status
What does the current market environment tell us?
|Fundamental indicators||Green light in December 2020|
|Technical indicators||Green 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.
The following picture illustrates the two different sets of warning lights — first for the fundamental indicators, then for the technical indicators — which determine, systematically, the risk-on or risk-off posture to be taken by the portfolios.
Thoughts on the market environment
The US presidential election turned out to be the starting point for a powerful rally, making this November one of the strongest months in history and leading to a new all-time high for the S&P 500. The majority of the gains were made in the first days of the month and were already reflected in last month’s strategy performance (as I record monthly gains on the day of the newsletter’s publication, the 5th of each month).
A slew of positive news hit the wires last month — first and foremost, the uplifting message that a highly effective Coronavirus vaccine will be available in the coming months. Everyone has been waiting to hear that, and I’m confident that people will be able to endure several difficult months, as the timeline that ends this pandemic is much clearer now — a light is shining at the end of the tunnel.
We are now in a solid bull market regime, which is the most profitable, “normal” environment, seen about 75% of the time. Falling volatility may soon change my classification to the most stable designation: a “Quiet Bull Market Regime.”
The months around the end of the year historically show the best returns. This tendency is supported by strong market breadth, as equities across all sectors now carry the rally (in contrast to the tech- / growth-driven performance of months past). Bullish sentiment and inflows into stocks are on the rise, to the extent that the chances for temporary setbacks are increasing.
In my weekly premium report, I’m looking to put some temporary hedges in place, should we see continuing strength into January.
The Meta Strategy signals
The Meta Strategy signaled a regime switch to a new bull market environment in July and fundamental indicators are now back to signaling a green light. Only minor pockets of weakness remain, despite recent new lockdown measures.
This is great news and signifies a high probability that the bullish scenario will continue. Thus, we can tolerate temporary weakness in the market (should it occur) and patiently wait for the next systematic exit signal from stocks. The probabilities are good that, whenever this signal may come, we will be at higher prices than our entry.
Here you can find a comprehensive 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 Class||Portfolio allocation|
|Risky assets: stocks||50%|
|Safe assets: bonds||0%|
|Alternative assets: gold||50%|
|Aggressive assets: short stocks||0%|
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 an up-trend and is in a bull market, that is supported by fundamental monetary conditions. Its relative strength has faltered somewhat in gold’s recent correction, and I am considering reducing the allocation in the near future.
I will wait for a period of strength in gold, paired with weakness in stocks, to do this. Alternatively, signs of an end to the gold bull market (a break below the long-term trend measure, the 275-day moving average) will trigger an exit.
Find the systematic rules governing the asset allocation in the model portfolios here.
|Defensive ETF portfolio||50% Gold & 50% S&P 500 ETF|
|Aggressive ETF portfolio||50% Gold & 50% 2x leveraged S&P 500 ETF|
Current regulations prohibit Eurozone investors from buying US-based exchange traded funds (ETFs), but they can choose EU equivalents. Several choices are usually available, and I list only 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
|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
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 US investors who use certain 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 dollars. Depending on an 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 highly versatile and can be used to allocate capital to individual trading strategies rather than just to broad market index ETFs. This adaptability has the potential to enhance performance or to hedge some of the portfolio’s volatility.
Meta Strategy Derivatives Portfolio
This holistic investment and trading portfolio, which 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.
Described here are 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. You can see what the weekly report looks like here.
Recent key market insights
We are seeing large flows into equities, after a long period of continuous outflows, combined with strong market breadth, as a large portion of stocks carries the current rally. My primary scenario is that many market participants have been waiting for a resolution to the US elections to position themselves in stocks, which could continue to provide a solid tailwind for equities going into the year end.
Strong breadth versus Sentiment
These are the big counterpoints in the current market. Signs of exuberance are on the rise, but the key question remains; How long can that rise continue, and when will it flip? Growing confidence is typical for a euphoric bull market, and strength underneath the hood lends long-term support. The art now lies in striking the right balance in interpreting the data: When will growing sentiment likely cease to be supportive of rising prices, making the market fragile and prone to flushing out its excesses?
At the moment, I see the highest chance that strong year-end tendencies will maintain the upper hand. Sentiment extremes, as well as equity inflows, still have some time and room to grow. Depending on the price development, some downside risks are likely to build up into the beginning of next year (late January to February).
I watch for warning signals from the options and volatility markets that might point to a potential flip, in case my main thesis turns out to be wrong, as deflating euphoria could potentially derail the rally at any time.
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:
|Date||Defensive Portfolio||Aggressive Portfolio|
|06.03.19||bonds, gold||bonds, gold|
|06.04.19||US stocks, gold||2x leveraged US stocks, gold|
|06.05.19||US stocks, EU stocks||2x leveraged US stocks, 2x leveraged EU stocks|
|06.06.19||US stocks, EU stocks||2x leveraged US stocks, 2x leveraged EU stocks|
|06.07.19||US stocks, EU stocks||2x leveraged US stocks, 2x leveraged EU stocks|
|06.08.19||US stocks, EU stocks||2x leveraged US stocks, 2x leveraged EU stocks|
|06.09.19||US stocks, EU stocks||2x leveraged US stocks, 2x leveraged EU stocks|
|06.10.19||US stocks, EU stocks||2x leveraged US stocks, 2x leveraged EU stocks|
|06.11.19||US stocks, EU stocks||2x leveraged US stocks, 2x leveraged EU stocks|
|06.12.19||US stocks, EU stocks||2x leveraged US stocks, 2x leveraged EU stocks|
|06.01.20||US stocks, EU stocks||2x leveraged US stocks, 2x leveraged EU stocks|
|06.02.20||US stocks, EU stocks||2x leveraged US stocks, 2x leveraged EU stocks|
|04.03.20||50% US & EU stocks||US stocks, EU stocks|
|05.05.20||gold||gold, short US stocks|
|05.06.20||gold||gold, short US stocks|
|05.07.20||gold||gold, short US stocks|
|05.08.20||gold, US stocks||gold, US stocks|
|05.09.20||gold, US stocks||gold, 2x leveraged US stocks|
|05.10.20||gold, US stocks||gold, 2x leveraged US stocks|
|05.11.20||gold, US stocks||gold, 2x leveraged US stocks|
|05.12.20||gold, US stocks||gold, 2x leveraged US stocks|
Historical performance backtest
A 15-year backtest, followed by two years of actual investment performance (06-2003 to 12-2020), reveals the advantages of the Meta Strategy Defensive (red) and Aggressive (blue) ETF Portfolios over a buy-and-hold portfolio. Specifically,for the Defensive Portfolio, losses in the worst bear markets were reduced, while overall returns were improved by 1% annually over the S&P 500 (grey).
This smoother ride can go a long way toward curing the sleepless nights of 2008/09 and March 2020.
These lower drawdowns clear the way for a responsible use of leveraged and inverse ETFs to enhance performance. The Aggressive Portfolio (blue) more than doubled the annual return of an investment in the S&P 500 in the backtest, generating 16,70% vs 6,73% annually and leading to 3,6x more money earned over the 15-year backtest period (not including dividends or transaction costs) and all with fewer that two allocation changes per year, on average.
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, on occasion, around 25% from its highs (in extreme circumstances, such as 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 reduce the maximum drawdown to around -12,5%, but can be expected to yield only half the return of the stock market.
Likewise, mixing the two ETF portfolios will result in a performance that lies somewhere between each one’s individually.
Backtested results are hypothetical and NOT an indicator of future performance.
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 in 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 text and images is permitted only with prior written consent by David Steets.