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The Meta Strategy ETF Portfolio
monthly issue #26, February 2021
Dear Reader,
We are witnessing very interesting times in the stock market — to say the least. It is difficult not to become overwhelmed by conflicting information and opinions that are steadily increasing in volume.
Investor speculation is reaching manic proportions. The seductive lure of extraordinary gains, receiving full coverage in the main-stream media, emboldens investors to engage in dangerous practices. Unfortunately, this phenomenon usually ends in a reaping, where many investors take enormous losses.
The GameStop saga, which played out over the past three weeks, is an excellent example of how the niche activity of retail investors can influence the stock market as a whole (as well as be harmful to participants who are just slightly off in their timing).
After the GME stock notched temporary gains of over 1000% for early traders (rising to prices widely above any sensible valuations), these gains quickly evaporated for most within just a few days (not coincidentally, just after being featured on every news source imaginable), leaving those late to the party holding the bag with losses of up to 90% down from the highs.
In the process, these wide price swings forced large hedge funds, who were on the other side of the trade (as short sellers), to suddenly liquidate large parts of their holdings to meet their liquidity requirements. This was widely believed to be the cause for the 5,6% drop in the S&P 500, which reverted just as quickly when restrictions were put in place to curb the most excessive behaviors. Below the surface, there are indications that the “plumbing” of the financial system had reached capacity limits, warranting these measures.
For us, this story serves as a reminder of what might happen on a larger scale in the coming months, as the stock market still continues to build up into a state of increased fragility. More violent corrections and rallies, than the relative calm we have become used to over prior months, may very well play out.
Such an increase in volatility shouldn’t cause us sleepless nights, as the underlying market environment is healthy and sound. All of our strategy’s fundamental leading indicators have returned to signal a green light, which will likely revert to warn of danger well before we see the arrival of a new bear market.
On the technical side market breadth and trend are strong, indicating above average probabilities for positive returns over a one-year time horizon.
While the Meta Strategy is not designed to exactly time a market top (which is impossible to do consistently), we can rely on it to preserve the majority of our gains by getting us out of the market shortly after the top, before the brunt of the next bear market.
I wish you all the best, and good investing!
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
As gold’s relative strength has faltered in the ongoing correction, I plan to change the allocation to stocks in the near future. I will use the next correction of over 10% in the S&P 500, to implement this switch. (Expect a short email message once we reach an opportune time window.)
| Defensive ETF portfolio | no changes |
| Aggressive ETF portfolio | no changes |
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, 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 defensive 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 define my assessment of the market environment. They are based on the price of the US stock market and the state of the US economy, predicated on the idea that the US is the dominant driver of asset prices worldwide. 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
While I do not think that the next correction will mark the end of the current bull market (because long-term fundamental and technical indications are overwhelmingly positive), I do expect intermediate problems to be a significant feature of 2021.
An epic battle is raging beneath the stock market’s surface, as broad market strength is facing off against excessive speculation. In that regard, the only thing that has really changed since last month are the individual assets involved. Basically, the top rank of the best performing investment has rotated between those that are the most risky — most of which are conventionally thought of as unsound and speculative.
During this change in leadership, great gains were often followed by steep losses (as in the recent meme-stock mania that I described in the introduction, but also seen in assets like Bitcoin and others). A new wave of stimulus is likely to fan the flames and increase volatility.
I expect that last week’s sharp pullback was only the beginning, and a scary correction is likely to follow before summer. But I also think that this corrective move will prove to be temporary, given the positive long-term backdrop. As always, I will heed the Meta Strategy signals as a precaution, should this scenario turn out to be wrong.
In essence, medium-term volatility (corrections and rallies), followed by a continuation of the long-term bull market trend, is the most probable path.
The Meta Strategy signals
All indicators — fundamental as well as technical — are now showing solid green signals. This might seem strange in light of the continuing economic restrictions imposed by the Coronavirus pandemic, but it is important to remember that the stock market tends to front-run economic developments. The Meta Strategy measures the trend of leading economic indicators to account for that, which means that a change to a bad economy from a catastrophic state generates a positive signal — the trend points up.
Conversely, extremely positive economic readings may indicate stock market fragility, as a slightly negative development can begin to impact heightened expectations disproportionately.
Overall, we are in a very bullish fundamental backdrop, and we can tolerate any temporary weakness in the market while we patiently await the next systematic exit signal.
Whenever it may occur, the probabilities are in our favor of exiting at higher equity prices.
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% |
| Cash | 0% |
| 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 – the portfolio’s default positioning.
Gold still acts as an alternative asset in our portfolio, but its relative strength has faltered in the metal’s ongoing correction, and I plan to change the allocation to stocks in the near future.
I will use the next correction of over 10% in the S&P 500, to implement this switch. (Expect a short email message once we reach an opportune time window.)
Alternatively, signs of an end to the gold bull market (a break below the long-term trend) will trigger an exit.
Find the systematic rules governing the asset allocation in the model portfolios here.
Current portfolio
| Defensive ETF portfolio | 50% Gold & 50% S&P 500 ETF |
| Aggressive ETF portfolio | 50% Gold & 50% 2x leveraged S&P 500 ETF |
ETF LIST
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 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 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 ETFs to track performance in US dollars. Depending on an investor´s location, currency fluctuations will 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
I expect the beginning of the year to be fairly difficult to navigate, as we are facing a complex situation with shifting, opposing forces at play and different scenarios that are equally likely to unfold.
The strength of the recovery from a recent pullback is extraordinary, and such broad momentum carries a message that mustn’t be ignored. It may well be possible that the 5,6% correction was purely a function of big hedge funds de-leveraging their exposure across the board, because of a manic squeeze in the most shorted stocks, and that it is already over without contaminating broader market sentiment and speculative fever.
Indeed, patterns that wreak havoc with investor expectations play out remarkably often in conditions similar to today. A great example is the beginning of 2010, after the first great post-GFC rally and after positive seasonality played out around the turn-of-the-year. In the beginning of 2010 a widely expected, moderate pullback happened, only to be followed by a painful and messy 17% correction that caught investors off guard.
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 Portfolio | Aggressive Portfolio |
| 06.01.19 | cash | cash |
| 06.02.19 | cash | cash |
| 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 |
| 10.03.20 | cash | cash |
| 05.04.20 | cash | cash |
| 05.05.20 | gold | gold, short US stocks |
| 05.06.20 | gold | gold, short US stocks |
| 05.07.20 | gold | gold, short US stocks |
| 13.07.20 | gold | gold, cash |
| 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 |
| 05.01.21 | gold, US stocks | gold, 2x leveraged US stocks |
| 05.02.21 | 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), roughly 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 in between each one’s individually.
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 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.