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Bear Market Strategies
Integrated Market Crash Protection: Safe Harbor, Risk-Off




 

Introduction

A Bear Market Strategy selects safe harbor investments during a market crash. Wall Street uses the terms risk-on / risk-off to describe a move to riskier investments with potentially higher yields during bull markets and a move to safer investments with typically lower yields during bear markets. When a market direction indicator (such as StormGuard or the Death Cross) signals that conditions have become bearish, a Bear Market Strategy automatically takes charge and selects from a list of trusted safe harbor investments, such as cash, money market funds, bond funds, gold bullion, or US treasuries. Numerous market direction and sentiment indicators have been developed over the years to help determine when to flee to safety. Although the basis for many of them sound promising, many are only poorly correlated with future performance, and none of them come close to the performance provided by StormGuard-Armor. (Some of the better ones are compared HERE). The remarkable difference between the yellow equity curves in the three Strategy charts below illustrate the combined importance of StormGuard-Armor and Bear Market Strategies.
 

Why Bear Market Strategies Matter

The yellow equity curve, compound annual growth rate (CAGR) and Sharpe Ratio (risk-adjusted return) in each chart above illustrate why Bear Market Strategies matter. All three investment Strategies rely on the True Sector Rotation algorithm to determine which one of the eight candidate SPDR sector ETFs to own each month during bull markets. However, the left-most Strategy has no market crash protection, the center Strategy additionally utilizes StormGuard-Armor to determine when to exit the market to the safety of cash, and the right-most Strategy further utilizes StormGuard-Armor in combination with Bear Market Strategy BMS-4 to select the best trending ETF during bear markets from among safe harbor candidates UST, TLT, BND, MBG, MUB, CORP, SH, and GLD.

Avoiding Hindsight Selection Bias is Critical

Treasuries:
Long-term US Treasuries have been the best performing asset class during recent bear markets because they have been more negatively correlated with US Stocks than anything else for nearly two decades.  However, the two have not always been negatively correlated, as is easily appreciated from the Rolling 5-year correlation between US stocks and 5-year Treasury chart (right). What this means is that they could become positively correlated again at some point in the future. Thus, considering only long-term treasuries for a bear market strategy based on their 15-year prior performance would be falling victim to hindsight selection bias, resulting in substantially increased portfolio risk during the next market crash.

Bonds: Similarly, bonds have not reliably been a safe haven during bear markets as illustrated by the Correlation between US stocks and 10-yr US Bonds chart (right). Furthermore, bonds are quite diverse. Whereas high yield, emerging market, and municipal bonds experienced mild to moderate losses during recent bear markets, mortgage-backed and aggregate index bonds were remarkably stable.

Gold: Although "gold bugs" view the precious metal as an investment that will protect them from market downturns, Gold's Correlation to the Equity Markets over the past 45 years has averaged zero, meaning gold at times has provided protection and at other times has not.  So again, not a reliable solution by itself.

The Solution? A Bear Market Strategy: While future correlations may be unknown, fortunately the current best-performing bear market candidate can be identified by a Bear Market Strategy utilizing our True Sector Rotation algorithm.


Investment Candidates for Bear Market Strategies

In order to reasonably model the performance of a BMS (Bear Market Strategy), its candidate investments must have performance data that spans at least one major market crash. Although most ETFs that might provide safe harbor during a bear market were originated only recently, most are based on indexes having much longer histories that can be used to artificially extend the ETF's data history for purposes of improved strategy modeling. The table below contains excellent candidates from these asset classes: long-term treasuries, bonds, inverse markets, gold bullion, and a hybrid mix of the inverse S&P500 index with gold bullion. Additional documentation and a list of numerous other extended ticker symbols can be found HERE.

 Bear Strategy Candidate ETFs:  Extended History Ticker Symbols  

Symbol Name Start Date  |  Orig. Date
SHY- Treasury, 1-3 Year 1-2-1992   |   8-1-2002
IEI- Treasury, 3-7 Year 1-2-1992   |   1-1-2007
IEF- Treasury, 7-10 Year 1-2-1992   |   8-1-2002
TLH- Treasury, 10-20 Year 1-2-1992   |   1-1-2007
TLT- Treasury, 20+ Year 9-1-1988   |   8-1-2002
BND- Vanguard Total Bond Market 9-1-1988   |  4-11-2007
BLV- Vanguard Long-Term Bond Index 1-15-1996  |  4-11-2007
CORP- PIMCO Inv. Grade Corp. Bonds 11-01-1995  | 09-21-2010
SH- Short S&P 500 9-3-1998   |  7-1-2006
SH88- Short S&P 500 9-1-1988   |  7-1-2006
GLD- State St. ETF SPDR Gold    1-3-1995  | 11-18-2004
SHGD- 50% SH and 50% GLD ETF Pair 9-1-1988   |  7-1-2006
Symbol Name Start Date  |  Orig. Date
UST- Treasury (2x), 7-10 Year 1-2-1992   |   1-1-2010
UBT- Treasury (2x), 20+ Year 9-1-1988   |   1-1-2010
TYD- Treasury (3x), 10 Year 1-2-1992   |   3-1-2009
TMF- Treasury (3x), 30 Year 9-1-1988   |  3-1-2009
FLBX- Treasury, Fidelity FLBAX 9-1-1988   |  3-1-2006
MUB- iShares National Municipal Bond 9-1-1988   |  9-11-2007
MBG- SPDR Mortgage Backed Bond 9-1-1988   |  1-27-2009
HYG- High Yield Corporate Bond 1-3-1995   |  3-1-2007
PSQ- Short QQQ NASDAQ 100 9-3-1998   |  7-1-2006
SDS- ProSh. UltraShort S&P 500 1-29-1993   |  7-14-2006
UGL2- ProSh. Ultra 2x Gold 1-29-1993  | 12-3-2008
SHUG- 50% SH and 50% UGL ETF Pair 1-29-1993   |  7-1-2006

• Note 1: Extended ticker symbols have a "-" added as a suffix to indicate they are the extended data version.
• Note 2: The above list is not an exclusive list of candidate funds for Bear Market Strategies. You may try anything.
• Note 3: SHGD- and SHUG- were created as a means to reduce individual ETF volatility and allow them to trade better.

Ready-made Bear Market Strategies

The table below details 11 high performance, ready-made Bear Market Strategies that eliminate hindsight selection bias and integrate easily with StormGuard for use with any Strategy. The first seven are ETF-based and are increasingly aggressive in their approach. The last four are designed for use with Strategies based on Vanguard, Fidelity, T.R.Price and Columbia mutual funds respectively. Any of them can be imported and customized to better suit your objectives.
 

Symbol Bear Market Strategy Name DSD Chart Bear-R Bear-SD Strategy-ID
$CASH Exit to a Money Market Fund - - - - - - 3.0% 0.2% - - -
BMS-1 BMS-1, IEF Bear Market 0 10.4% 5.1% 636082731574875000-118-7-179148
BMS-2 BMS-2, TLH Bear Market 0 13.4% 6.4% 636082731574875000-118-8-179149
BMS-3 BMS-3, TLT Bear Market 0 16.5% 11.1% 636082731574875000-118-9-179150
BMS-4 BMS-4, UST Bear Market 0 20.7% 11.5% 636082731574875000-118-10-179151
BMS-5 BMS-5, UBT Bear Market -1 36.5% 17.5% 636082731574875000-118-11-179152
BMS-6 BMS-6, TYD Bear Market -1 40.4% 18.8% 636082731574875000-118-12-179153
BMS-7 BMS-7, TMF Bear Market -2 54.2% 27.2% 636082731574875000-118-13-179154
BMS-V BMS-Vanguard Bear Market 0 13.1% 10.6% 636082731574718750-118-1-51918
BMS-F BMS-Fidelity Bear Market 0 15.2% 9.7% 636082731574875000-118-3-179145
BMS-T BMS-T.R.Price Bear Market 0 14.7% 9.7% 636082731574875000-118-4-179146
BMS-C BMS-Columbia Bear Market 0 12.0% 9.1 636082731574875000-118-5-179147

Note: Bear-R and Bear-SD values are as of 9/1/2016

• Note 1: DSD column in the above table refers to the Decision Shift Days advanced option. It is presumed that: (a) BMS-5 and BMS-6 will be primarily associated with some of the narrower sector ETFs and 2x ETFs that generally perform better with a DSD setting of -1, and (b) that BMS-7 will be primarily associated with 3x ETFs that often perform better with a DSD setting of -2.
 
• Note 2: Bear-R refers to the annualized return a Bear Market Strategy produces only when StormGuard-Armor is triggered. Bear-SD is its corresponding annualized standard deviation. They are reported in the chart's subtitle. (A BMS name starts with "BMS-" or "Bear" and has StormGuard disabled.)

• Note 3: All of the mutual fund Bear Market Strategies include the special ETF based SHGD- ticker symbol. Depending on your brokerage  and account type, you may find trading between mutual funds and ETFs problematic because of settling time rules. There are three options for dealing with this problem: (a) import the Bear Market Strategy and edit it to remove SHGD-, (b) wait for the settling time to clear, or (c) change your account or brokerage to one that alleviates this problem.

Contrast: The comparative benefit and character of the seven ETF Bear Market Strategies is illustrated in the chart (right) for the simple strategy of owning SPY unless StormGuard-Armor indicates moving to safety with a Bear Market Strategy. Note the significant differences in total return, return uniformity, and general volatility. 

Guidance: Selecting a Bear Market Strategy is primarily a matter of judgment involving investment risk tolerance. Since the character of the main Strategy's candidate funds is already a statement of investment risk tolerance, using a Bear Market Strategy of similar character is appropriate. For example: (a) a broad asset class Strategy typical of a 401k plan would be best matched to BMS-2 or BMS-3, (b) a sector rotation strategy would be best matched to BMS-4 or BMS-5, and (c) an aggressive 2x or 3x leveraged fund strategy would be best matched with BMS-6 or BMS-7.

Creating a Custom Bear Market Strategy

The best way to create a custom Bear Market Strategy is to start by importing and modifying an existing one. Examples include: (1) BMS-Vanguard may be more suitable if the ETF duo SHGD- were deleted, (2) BMS-Fidelity may perform better if it were more aggressive and included UST-, (3) A BMS could be modified to incorporate UGL- or GDX- directly, or (4) ETFs not considered above may be found to further improve performance while still reasonably addressing hindsight selection bias.

In order to use your custom BMS in another Strategy, you must identify it using the special ticker symbol format of ADnnn, meaning AlphaDroid Strategy #nnn (where nnn has no leading zero). For example, if your BMS is Strategy #24, then use AD24 as the special ticker symbol when specifying it in the Advanced StormGuard Options Bear Symbol field of any Strategy for which AD24 is to act as the Bear Market Strategy.

 
• Tip 1: Since Strategies are evaluated each evening in the sequential order of their Strategy numbers, make sure the Strategy number of each BMS is lower than the number of any Strategy that uses it so its results will be current.
 
• Tip 2: The Bear-R and Bear-SD values (annualized return and standard deviation produced during periods when StormGuard-Armor is triggered) are reported in the BMS chart subtitle (when its name starts with "BMS-" and StormGuard is disabled) to help simplify BMS development.

• Tip 3: After editing a Bear Market Strategy, other Strategies that employ it will not be aware that it changed and thus will not display updated charts or statistics until its own algorithm has been re-run. Although every Strategies is automatically processed late each night, a Strategy can be forced to immediately re-run its algorithm by editing one of its key properties, such as a ticker symbols. (i.e. either delete a blank ticker symbols, or replace one with the same ticker symbol.)

How to Specify StormGuard and a Bear Market Strategy

StormGuard OptionsStormGuard options are located on the Strategy Information popup window, which is accessed by clicking the  icon next to the Strategy's name on the Strategies Management page. Click the button to expose them and make your selection from among the StormGuard Options shown. In addition to the six StormGuard methods for detecting the onset of a bear market, the Bear Symbol provides a method for determining which investment should be held during bear markets by specifying its ticker symbol. Although $CASH (a generic symbol used to mean "your favorite money market fund") is the default symbol, you may use any other ticker symbol of your choice, including those for: (a) ETFs and mutual funds, (b) extended history symbols, (c) ready-made Bear Market Strategies (listed above), or (d) the special ticker symbol for referencing one of your own Strategies using the format of ADnnn, for AlphaDroid Strategy #nnn (where nnn has no leading zero).

Examples Speak for Themselves

Below are a set of Strategy pairs showing the stark contrast between using: (a) the well-known and respected Death Cross a algorithm to determine when to move to the safety of a money market fund, versus (b) the better performing StormGuard-Armor algorithm, which determines when to switch to a Bear Market Strategy. In the charts below, the Strategy equity curve is multi-colored to show which of the candidate funds was owned at any particular time. The equity curve is white when the Death Cross or StormGuard algorithms have triggered and have commandeered the investment decision.


Example 1:   Mainliner
Selecting the trend leader from among the broadest of market index ETFs.

Death Cross triggers exit to money market fund.

StormGuard-Armor triggers Bear Market Strategy.


Example 2:   SPDR Sectors
Selecting the trend leader from among SPDR sector ETFs.

Death Cross triggers exit to money market fund.

StormGuard-Armor triggers Bear Market Strategy.


Example 3:   ETF Countries
Selecting the trend leader from among iShares country ETFs.

Death Cross triggers exit to money market fund.

StormGuard-Armor triggers Bear Market Strategy.


Example 4:   2X Regions and Sectors
Selecting the trend leader from among 2X leveraged world region and sector ETFs.

Death Cross triggers exit to money market fund.

StormGuard-Armor triggers Bear Market Strategy.