Using economic indicators to time the market – part 2

In my last post I looked at using the change in trend of the unemployment rate as a market timing indicator. The results were impressive to say the least – almost a doubling of risk adjusted returns over buy and hold. In this post I want to make the analysis I did a little more real world by adding safe assets to the mix.

Let’s take the same analysis from the last post and add US gov’t bonds as the safe asset to switch into when the market timing indicator triggers an exit from US stocks. I’ll use real world ETFs. SHY for the the short term safe asset. IEF for the intermediate term safe asset and TLT for the long term safe asset. The only negative in doing this is that these safe asset ETFs don’t have a long history. They only go back to about August 2002. But there is still a good deal of insight to be gained in how these systems work in several quite distinct market environments. We can also do one more thing. We can combine the unemployment indicator with the traditional market timing indicators, SMA and absolute momentum. Below is the table with the results.

As in the last post, where the time period looked back to 1999, the SPY-UI indicator strategy outperforms both of the traditional timing strategies. By adding any of the safe asset ETFs we get even better performance with the best performance coming from switching into intermediate government bonds. This is consistent with other strategies – intermediate term bonds are the best safe asset to add to the mix.

Of course the obvious next question, is what happens when you combine a traditional timing systems with the new UI system. This is exactly what PhiloEcon did in the GTT system. The combination system works like this.  As long as the UI indicator has not triggered, the system is long the risky asset. Once the UI indicator triggers then the system uses the traditional timing indicator (200 day SMA or 12 month abs momentum) to determine when to exit the risky asset. Once the system is out of the risky asset it is invested in the safe asset. This is what the last two lines of the above table show. The results are mixed, at least in this short timeframe analyzed. Combining the UI system with the 200 day SMA yields slightly better return but slightly lower risk adjusted returns. Using the UI system with the 12 mo abs return produces lower results.

In summary, adding a safe asset to the UI system produces even better results over the standalone system. And combining the UI system with traditional timing systems also produces impressive results. Way better than buy and hold to say the least. Now, you can make further extensions to the system. How about foreign risk assets?  How about using momentum across risk assets combined with the UI system? That’s what we’ll look into in a future post. Stay tuned.