In the current market environment, in order for us to make tactical decisions and define and manage the risk in our portfolio, we use component #1 identify and measure the annual returns of “overperformance” of the S&P500 index versus it’s “baseline” . Further identified are consecutive years of “overperformance”and 2014 represented the 3rd year of “overperformance” by this quantification. The chart below shows previous occurrences of of subsequent returns after the consecutive years of “overperformance”:
This gives us preliminary knowledge towards “mapping” risk to reward in the upcoming market environment. As shown above, statistically, odds of consecutive years of overperformance leading to negative returns are slightly more than 50% since 1924. Another way of stating this would be “the odds on which price will revert back to the “mean” in relation to past occurences”.
To be conclusive in our decision making process, we look next to component 2, which is a time series calculation conducted on performance of SP500 over specific months, categorized into risk profiles ( Favorable, Neutral, and High) applied towards upcoming year and guides towards actionable tactical allocation decisions (with final risk profile readings being calculated in the 3rd week of January ( 01/16/2015 )). In the present case, since the consecutive years of outperformance regime has occurred, we look for the following:
1) a “neutral” or “high” risk profile reading will shift the portfolio allocation towards a “cash” position or
2) a “favorable invest 1st half of year” risk profile will keep the allocation in equities / Powershares QQQ ( QQQ ) until the first week of Jul. The charts below reflect past risk profile return outcomes.
The chart below illustrates historical returns from the ” Favorable Invest 1st Half ” and “High” risk profiles:
Stay tuned for update on weekend of 01/16/2014 …
For further explanation on the model see post : https://stockmarketmap.wordpress.com/2013/08/29/market-map-basic-version/
The recent performance of component #4 ( 4th quarter of 2014; when which we allocated to QQQ from TLT ) was again positive contributing to further statistical significance and long term alpha. The charts below show all historical returns for component 4 “select 4th quarters” since 1924, including the 4th quarter of 2014 :