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The Meta Strategy ETF Portfolio
monthly issue #32, August 2021
Yesterday, on August 5th, the S&P 500 closed at its 43rd all-time high this year. It seems like nothing can stop this liquidity-driven momentum rally, despite it being carried by fewer and fewer large cap stocks. Much as in the markets of 2013/14 or 2017, every pullback is shallow and immediately bounces back to new highs.
It is a perfect environment for a leveraged portfolio overweighted towards US stocks (the Meta Strategy Aggressive ETF Portfolio), when bad news and good news always seem to propel equities higher. Even the concerning spread of the Coronavirus Delta Variant continues to be viewed as a development that will keep the pockets of Central Banks wide open and liquidity flowing freely — a net positive for stocks.
Naturally, this cannot last forever, but 2021 shows once again that momentum often persists much longer than most market participants expect. Long-term concerns, like lofty valuations or rising inflation, as well as medium-term warning signals, for example weakening market breadth or a historically weak summer season, continue to be trumped by easy money and momentum. We have seen such warning signs before, in the beginning of this year, and they haven’t mattered much beyond leading to minor pullbacks in the S&P 500.
This shows that it is best to simply stick to a systematic long-term portfolio allocation, even if we could easily see a more serious shake-up between now and October.
There is not too much to worry about beyond increased dangers of a short-term correction, as all of the Meta Strategy’s fundamental leading indicators signal a green light, and they will likely revert to warn of danger well before we see the arrival of a new bear market.
On the technical side, the trend is very strong and volatility is settling into a lower range. The Meta Strategy has safeguards in place that will signal an exit after a market peak, but before the onset of the worst part of a new bear market.
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 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||Technical Indicators|
|Green light in December 2020||Green light for re-entry into stocks on July 10th, 2020|
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.
Leading Fundamental Economic Indicators
|Indicator||LEI||10-Year Minus 3-Month Treasury||Unemployment Rate||Initial claims||Retail sales||Financial Conditions|
|Warnig if||6mma RoC < 0||T10Y3M < 0||Rate > 12mma||12wma > 52wma||6mma RoC < 0||> 0|
|Indicator||Long Term Trend||Long Term Trend Confirmation||Volatility||Volatility Severe|
|Warnig if||S&P < 275dma||S&P 60dma < 275dma||VIX Futures Contango < -1,5%||VIX Futures Contango < -9%|
The following graph 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
Increasing warning signs, which I have talked about in last month’s report, continue to matter very little for now. This means that many underlying issues remain unresolved, and there is a steadily increasing possibility that the current, relentless rally will not be able to sustain its pace for much longer. It would be only natural to see extended consolidation periods and price corrections in the broad market over the summer.
The extraordinary rally in large cap US stocks is driven, in large part, by unprecedented liquidity from central banks. This means that the increasing Delta Variant concerns that appeared over the last months are seen as positive for stocks, as they will likely hold upcoming FED tapering and other monetary restrictions at bay for longer than expected.
However, the broad indices still show little participation at new all-time highs. The longer weak market breadth persists, the higher the likelihood that this foreshadows medium-term weakness in equity markets. This now coincides with the historically weakest months of the year, August and September — a tendency, which is especially pronounced in post-election years, when the initial excitement over a new presidency tends to start tapering off.
On the fundamental side, surprisingly high inflation numbers hint at future problems, especially as current economic data is starting to disappoint expectations more often than not. For now, no problems are showing up in the Meta Strategy’s leading indicators, and this will likely change before we see a more serious decline.
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||100%|
|Safe assets: bonds||0%|
|Alternative assets: gold||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.
The portfolio diversifies broadly across US and international equities. The S&P 500 and international stocks take turns in their role as performance leaders. Recently the US has taken over leadership once again, though not long enough to justify a switch into a more concentrated portfolio.
Find the systematic rules governing the asset allocation in the model portfolios here.
|Defensive ETF portfolio||50% World ex US ETF & 50% S&P 500 ETF|
|Aggressive ETF portfolio||50% 2x leveraged World ex US ETF & 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
World ex US stocks: VEU
2x World ex US stocks: EFO
|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
World stocks: SPDR MSCI World UCITS ETF – USD ACC ETF; WKN: A2N6CW ISIN: IE00BFY0GT14
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 defensive and aggressive ETF portfolios (50/50).
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, though these tend 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 Defensive and Aggressive ETF Portfolios with a trading strategy using derivatives (e.g. options or futures), is now available as a premium subscription.
Investors that seek to include a short- to medium-term return outlook in their process can use this data-based, discretionary framework.
Currently, a good way to take advantage of potential temporary stock market weakness over the summer would be to implement a covered call strategy. An investor would sell a call option equal to her ETF holdings with an expiration in December and a strike above current market highs. The premium received would enhance returns in down-, sideways- and moderately up-markets. The only risk a covered call represents is that the return potential of the Meta Strategy ETF Portfolio is capped at the strike price until December, if the relentless rally continues.
Read about my process in detail here, and see what the weekly report looks like here.
Historical performance backtest
A 15-year backtest, followed by 2.5 years of actual investment performance (06-2003 to 08-2021), reveals the advantages of the Meta Strategy Defensive (green) and Aggressive (blue) ETF Portfolios over a buy-and-hold portfolio. Specifically, for the Defensive Portfolio, losses in the worst bear markets were reduced, which improved overall returns over the S&P 500 during troubling times (light green). 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 (light blue). 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 the middle.
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.