Elran's  Instablog

Send Message
I am a senior electrical engineer and inventor ,my job is to find insightful solutions to address technology related needs. I started investing 12 years ago, and it is a hobby i take very seriously.I use my technical and academic skills to engineer consistent and reliable strategies aiming to... More
My company:
Alpha Asset Allocation
My blog:
Alpha Asset Allocation - Asset portfolio
  • Market TIming Using TED Spread 5 comments
    Nov 14, 2013 10:39 AM

    The TED Spread measures the difference between the three-month LIBOR (interbank loans rate) and the three-month T-bill interest rate, it is a commonly used indicator of perceived credit risk. An elevated TED spread readings is a sign that lenders believe the risk of default on interbank loans is high and therefore, demand a higher rate of interest relative to T-bills (which are considered risk free).

    So does the TED spread give us any clue on future performance of the stock market?

    Look at this graph :

    (click to enlarge)TED spread Vs S&P500

    In the above graph we can see that before and during bear markets (1987,2000-2002,2008) TED spread tend to be high. Looking more closely we can identify that there is a positive short term correlation between TED spread and S&P500, Meaning that rising TED spread tend to lead to better stock market performance.

    We can take advantage of this positive leading correlation by using a very simple market timing strategy: In the last day of every month calculate the TED spread if the spread increased during the month, buy the S&P on the next opening and hold it for one month, if the spread decreased during the month, sell the S&P on the next opening and hold cash one month.

    I backtested this strategy from 1987 until 2013 see the graph below :

    (click to enlarge)Ted spread market timing strategy - backtest results

    The strategy spent 45.8% of the time invested in the market yielding return of 12.13% (not including dividends).

    The CAGR=12.13*45.8%=5.56%.

    Max drawdown was -28.44%

    Sharp ratio =0.44

    Being in the market in the rest (56%) of time when the last month TED spread decreasing would have resulted with yield of 3.67% and Max draw down of -60%.

    We can even make this strategy much better by adding another rule to the existing strategy :buy only if TED spread is <1.5, This will prevent us from jumping into the market during very high credit risk periods which usually means bear market conditions for the S&P500.

    Look at the results of the improved strategy :

    (click to enlarge)TED spread improved strategy

    The improved strategy spent 44% of the time invested in the market yielding return of 16.3% (not including dividends).

    The CAGR=16.3*44%=7.17%.

    Max drawdown was -24.66%

    Sharp ratio =0.8

    We can see that the TED spread does a good job as a leading market indicator, so it worth following.

    Follow us for more strategies involving Tactical asset allocation.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Back To Elran's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (5)
Track new comments
  • Janet86
    , contributor
    Comments (2) | Send Message
    great share..
    very informative!
    17 Nov 2013, 12:05 PM Reply Like
  • AAinPB
    , contributor
    Comments (2) | Send Message
    Sorry to be slow, but what do you mean by the spread <1.5:


    LIBOR divided by T-Bill <1.5?


    The current figures are LIBOR =0.24 and T-Bills =0.06 for a ratio of about 4.0 and a delta of about 18bps.


    Help! Thanks very much.
    1 Dec 2013, 01:47 PM Reply Like
  • Elran
    , contributor
    Comments (63) | Send Message
    Author’s reply » Ted spread =LIBOR minus T-Bil < 1.5
    Using your data the current Ted spread is 0.18 , indicating rather low credit risk as perceived by banks.
    1 Dec 2013, 04:52 PM Reply Like
  • AAinPB
    , contributor
    Comments (2) | Send Message
    Thank you! I guess I shouldn't be so skeptical when it seems too simple/too good!
    1 Dec 2013, 10:20 PM Reply Like
  • Elran
    , contributor
    Comments (63) | Send Message
    Author’s reply » I always prefer simple strategies as long as they have a sound logic behind it - the logic behind this system is that you get in the market when fear is rising but not at extreme levels.
    2 Dec 2013, 05:47 AM Reply Like
Full index of posts »
Latest Followers


More »

Latest Comments

Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.