Market Map Model: Risk Profiles

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

This chart shows low market risk years as referenced from the MM model.  ScreenHunter_779 Aug. 29 20.33

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 :

ScreenHunter_780 Aug. 29 20.43

NEUTRAL RISK

Equity investment in years with “neutral” risk profiles had positive return skew yet with increased tail risk:

ScreenHunter_777 Aug. 29 20.29

HIGH RISK

High risk profile years had decidedly negative individual year and median returns:

ScreenHunter_776 Aug. 29 20.18

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”.