MTS4: Systemic Market-Timing For All Investors

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Includes: SPY
by: Fred Piard

Summary

What are Multi Timing Scores.

Why they are safer than the usual market-timing indicators.

An actionable example.

Multi Timing Scores are multi-valued market timing indicators focused on a long-term investing horizon, including the 4 main categories of market analysis: sentiment, economy, fundamentals, technicals. They count bearish signals among a set of elementary indicators based on economic data and S&P 500 companies. Indicators are chosen based on publications and consensus, they are not optimized. Multi Timing Scores gather them and makes the assumption that any of them may be wrong at any time, but not most of them at the same time.

By definition, a systemic model is a model able to cope with complexity, which implies coping with uncertainty. Market timing scores take into account uncertainty about signals, and even that an indicator may be irrelevant. This makes them not only systemic, but also more robust than usual optimized indicators. Another characteristic of Multi Timing Scores is that they are multi-valued. The usual market-timing indicators are binary: they tell when you should be in or out of the market. Market conditions are more complex than risk-on / risk-off. Multi Timing Scores do not aim at making predictions, but at telling when the ecosystem is favorable to black swans. They can be considered as risk indicators, but the risk is not necessarily proportional to the score. The best way to understand Multi Timing Scores is to compare them with another score well-known by back-country skiers and mountaineers: the avalanche danger scale. When the level is maximum, it is strongly recommended to stay at home. But even when it is at its lowest value, zero risk does not exist. Fortunately the danger is less acute in investing. Mountains (a tough school of risk management) teach something else: regarding risk, expertise and experience don't matter. Accident reports show that experts and professionals have more or less the same risk as beginners. Knowledge and routine are an advantage, except when they lead to an excess of confidence. Hence, the importance of having an objective view of risk built on facts and indicators, and always keeping in mind that zero risk does not exist.

Market Timing Scores can be used in two ways:

  • Defining an alarm level: the indicator value beyond which the benchmark average return is negative. It can be used to go in cash or take a hedge. The calculation is dependent of a backtest period.
  • Hedging by thresholds. The hedge (for example shorting a stock index) is sized depending on the indicator value. Various tactics are possible, and backtesting may help make a better choice depending on the priority: risk reduction, drawdown duration reduction or return maximization.

I will disclose now a simple and actionable version of Multi Timing Score with 4 components: MTS4. It is calculated from 4 elementary values (a,b,c,d) defined as follows:

  • If the unemployment rate is above its value 3 months earlier, then a=1; else a=0.
  • If S&P 500's current-year EPS estimate is below its value 3 months earlier, then b=1; else b=0.
  • If S&P 500's 50-day sma is below the 200-day sma, then c=1; else c=0.
  • If the 52-week sma of S&P 500 companies' average short interest is above the 104-week sma, then d=1; else d=0.

MTS4 is simply the sum a+b+c+d. As a consequence, it is an integer between 0 and 4. Readers willing more insights on the choice of elementary indicators can refer to this article and this other one.

The charts and table hereafter report simulations of SPY when MTS4<=n, n varying from 0 to 3 (n=4 is the benchmark because the condition is always true). In other words, it is SPY going in cash when MTS4>=n+1.

The period includes only 2 market cycles (01/01/2001 to 07/22/2015). Most components have been chosen from academic or professional publications studying elementary indicators on longer periods.

Data and charts: portfolio123

MTS4=0:

MTS4<=1:

MTS4<=2:

MTS4<=3:

n

AnRet

MDD

STD

Sharpe

0

4.55%

-9.80%

5.79%

0.52

1

7.67%

-20.15%

9.10%

0.70

2

12.18%

-20.15%

10.22%

1

3

10.42%

-29.09%

12.04%

0.73

4 (benchmark)

5.45%

-55.42%

15.26%

0.29

AnRet: annualized return; MDD: max drawdown depth; STD: standard deviation; Sharpe: Sharpe ratio.

The average return and risk-adjusted return (Sharpe) grow from n=0 to n=2. When using MTS4 as a timing indicator, it is better to go in cash or full hedge when MTS4>=3. It is the alarm level.

The description above explains how to calculate MTS4 manually. For readers who don't have access to all data or want a calculation in one click, this page explains how to get a limited free access to the code of MTS4 in a popular screener, backtest it, and get its value at any time. Feel free to copy and use the code or the indicator description above (in respect of CC BY-NC license).

The Multi Timing Score used in my premium service is called MTS10 and has 10 components. It is more robust to flawed signals: an indicator missing a bearish signal or giving a false one represents 25% of the total in MTS4, it is 10% in MTS10. It is also more robust to economic data revisions, and offers a better safety margin regarding the alarm level. The optimal alarm level is 7, but any value between 5 and 9 works well. However, both MTS4 and MTS10 may help investors protect their portfolios when there is a high risk of avalanche in the stock market.

When I write this, the values of MTS4 and MTS10 are respectively 0 and 3, which is below their alarm levels. A low value means that a cyclical bear market is very unlikely in a near future. Market corrections and unpredictable events can never be excluded.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short S&P 500 for hedging purposes.