Mebane Faber had a great post on Successful Market Timing. His post also contains excerpts from a Paul Merriman article called Do you have what it takes to be a successful market timer? Both are excellent reading.

As both Faber and Merriman point out, following a mechanical market timing system takes considerable discipline. While it sounds simple, emotions are a very powerful thing - they can compel us to act impulsively. To be a successful market timer, one must be able to control one’s emotions and impulsiveness. The beauty of a mechanical market timing system is that it is absolutely unemotional - the voice of reason. To the timing model it’s simply applying rules and formulas to a bunch of data. To humans it’s a tug between the extremes of fear and greed. 

Whenever you start to feel fear and doubt, go back and read Faber and Merriman to get grounded. Deep inside, you just might have what it takes.

I’m working on some new features for the Sage Investment Strategies Timing Model (SISTM):

–Expanding the reporting period from 1 year to 3 years
–Developing new SIS portfolios based on risk selection

Take a look at the sample chart and table below which contain six new SIS portfolios and 3 years of performance data. I like the 3-year look-back because it provides a better performance comparison with benchmarks over a longer time period. One of the challenges I faced with the 3-year look-back is that some of the ETFs in the portfolios (particularly some of the bond ETFs) were either not around 3 years ago or there was not enough data for the model to evaluate. The model allocates a higher proportion to a money market fund until enough data is available in those cases. 

I addded a few new data points including 3-Year Return and 3-Year Compounded Annual Growth Rate (CAGR) to the tables. In addition, Maximum Drawdown, Standard Deviation and Sharpe Ratio are all based on 3 years of data instead of just the most recent year’s data.

I decided to provide a range of SIS portfolios based on risk as measured by standard deviation and maximum drawdown. I decided to keep the original SIS Basic Portfolio (with the same 5 asset classes but different investment vehicles than our current SIS Basic Portfolio) and to develop a series of 5 new portfolios based loosely on the current SIS Long & Short portfolio. The key benefit provided by the new portfolios is that subscribers will be able to easily choose the most appropriate portfolio based on their risk comfort level.

The 5 new portfolios are aptly named Conservative, Moderately Conservative, Moderate, Moderately Aggressive and Aggressive. The maximum expected drawdown for the 5 new portfolios are calculated roughly as 5%, 10%, 15%, 20% and 25% respectively. I base those expected maximum drawdown numbers on how the new portfolios would have fared under the tumultuous market conditions of the last 3 years. In comparison, the S&P 500 Index fell as much as 67% and a typical investor’s portfolio of 60% stocks and 40% bonds fell as much as 41% during the same period.

The chart and tables below show a good comparison of risk and reward for the new portfolios as well as the same 2 benchmarks we currently use. The 3-year returns of the 6 new SIS model portfolios ranged from +15.8% to +29.1%, whicle CAGRs ranged from 5.0%-8.9% annually. In contrast, the S&P 500 Index is 21.5% lower than where it stood 3 years ago which translates into a CAGR of negative 7.8%.

The chart provides a great snapshot of how the benchmarks outperformed the SIS portfolios from August 2006 until October 2007 when the market peaked, and the reversal of fortune that occurred since then.

I’m still working on the model for the new portfolios and plan to roll it out to subscribers later this year. Stay tuned!