In the previous article , we presented an overview of the goals, variables, and performance statistics of Market Map Model. In this article, we display an example of a variable used towards signaling decision heuristic.
When building an allocation model featuring longer length signaling time frames, it was important to determine the risk to reward of an upcoming year. One variable in the model is derived from a time series analysis conducted on a monthly data series that has produced statistically significant results. The results were categorized and then built into a heuristic. We have called these “Risk Profiles”.
As shown in the charts below, positive outcomes ( hence, equity allocation ) have been during “Favorable risk” profile years and “Favorable risk First 6 months” years. And neutral to negative outcomes ( hence cash / Bond allocation ) have occurred during in “Neutral risk”. “High Risk” profile years, and the 2nd half year of “Favorable Risk invested First 6 months” years.
FAVORABLE RISK FIRST 6 MONTHS
This chart identifies the “low risk years with investment in the first 6 months of the year” profile and ensuing 6 month return resulting in cash position :
Equity investment in years with “neutral” risk profiles had positive return skew yet with increased tail risk:
High risk profile years had decidedly negative individual year and median returns:
As calculation in 2012 deemed 2013 as a Favorable Risk year candidate, the YTD S&P500 return of 16% ( as of this writing) seems unsurprising in the context of the average historical Favorable risk year returns. The end of the year will provide more definitive data.
The next article will combine the risk profiles with the seasonally popular “Sell in May/Six-Month Switching Strategy”.