US Leading index, when high can set max stock allocation?

[Lsbcal]

I've been looking at the chart of the US Leading Index shown here: https://fred.stlouisfed.org/series/USSLIND



This chart is for all the states and is described as follows:

Quote:

The leading index for each state predicts the six-month growth rate of the state's coincident index. In addition to the coincident index, the models include other variables that lead the economy: state-level housing permits (1 to 4 units), state initial unemployment insurance claims, delivery times from the Institute for Supply Management (ISM) manufacturing survey, and the interest rate spread between the 10-year Treasury bond and the 3-month Treasury bill.

So how to use this information? First it turns out that the data for a given month is not known until around 6 weeks later. So I think it is not so useful for determining when to get out of stocks as a recession nears. There have been 3 recession periods (grey areas in chart) in the last 36 years. And those grey areas are only determined and published many months after the start of a recession.

But perhaps the Leading Index is useful for giving one confidence when the value is in the high range, like above 1.0. For instance, as of April 15 the value for February 2018 is given as 1.59. What that seems to say to me is that I could maintain my max stock allocation with a reasonable level of confidence we will not be entering a recession any time soon. We could still have a nasty decline but it is likely to be short lived. I guess a "temporary" decline could be followed by actual recessionary conditions which makes that decline more sustained but that does not seem to have happened in the 36 years of this chart.

So I'm thinking of having a slice of my stock allocations (5% to 10%) that are shifted to bonds only when the Leading Index falls below a value like 1.0. This would perhaps be better then keeping that slice in bonds permanently.

Thoughts?

[NW-Bound]

It would be interesting to see the above chart superimposed on a plot of the S&P.

I am a bit lazy at the moment. Perhaps you have done the above, and can share it?

[Lsbcal]

I will look into this tomorrow. The chart would have to show the 6 week delay in reporting.

[Lsbcal]

Here are some results for the following rules:
1) Hold intermediate Treasuries (VFIUX) if the Leading Index is below 1.2
2) Hold the SP500 (VFIAX) if the index is above 1.2
3) Do not switch until you are in an asset (Treasury or SP500) for at least 3 months
4) Switch on the 1st of the month

Results for1982 to present:

SP500 11.8%
Treasury 7.1%
Switch 14.0%
Trades = 0.6 per year (1 trade about very 2 years on average)

Some results by decade:

1982 thru 1989.... SP500=17.2 Treasury=11.4 Switch=18.9
1990 thru 1999.... SP500=18.1 Treasury=7.1 Switch=17.8
2000 thru 2009.... SP500=-1.0 Treasury=6.1 Switch=8.6
2010 thru now..... SP500=13.2 Treasury=2.8 Switch=11.7

It seems this method accomplishes what I set out to do. That is, beat bonds with very low risk. Over the time period studied it happens to beat the SP500 too but not every subperiod.

You do have to pay attention and occasionally be willing to switch between Treasuries and the SP500. I don't worry about taxes since all trades are in retirement account.

[Lsbcal]

I'm impressed at the low response rate. Maybe I should have been more provocative? Or maybe people aren't interested in "chicken little" switch strategies?

I've allocated 10% to a version of this strategy. I figure on getting better then bond returns on this slice with very moderate equity risk. Still I will have to accept the occasional scary downdrafts that do not last but a few months (as opposed to recession/depression scenarios).

[HFWR]

Quote:

Originally Posted by Lsbcal I'm impressed at the low response rate. Maybe I should have been more provocative? Or maybe people aren't interested in "chicken little" switch strategies? I've allocated 10% to a version of this strategy. I figure on getting better then bond returns on this slice with very moderate equity risk. Still I will have to accept the occasional scary downdrafts that do not last but a few months (as opposed to recession/depression scenarios).

Sounds too much like w*rk! 🤫

[OldShooter]

Quote:

Originally Posted by Lsbcal I'm impressed at the low response rate. ...

Speaking solely for myself, I think that technical trading strategies have been so thoroughly debunked that I have zero interest in them.

Think about it this way: There are well north of 10,000 mutual funds, endowment funds, etc. out there. So let's guess that there might be 20,000-50,000 people trying to find an advantage in the markets. If a simple technical strategy like this actually worked, several thousand of these people would have noticed and tried to exploit it with hundreds of millions if not billions of dollars. When that happens, the strategy no longer works. Charles Ellis, in his book "Winning the Loser's Game" develops this theme, arguing that all the bright people in the business basically cancel each other out, leaving us with random walks.

[Lsbcal]

Quote:

Originally Posted by HFWR Sounds too much like w*rk! 🤫

I find it is fun. Did not find w*ok that way. Tends to satisfy a desire to exorcise some analytical demons.

[Lsbcal]

Quote:

Originally Posted by OldShooter Speaking solely for myself, I think that technical trading strategies have been so thoroughly debunked that I have zero interest in them. Think about it this way: There are well north of 10,000 mutual funds, endowment funds, etc. out there. So let's guess that there might be 20,000-50,000 people trying to find an advantage in the markets. If a simple technical strategy like this actually worked, several thousand of these people would have noticed and tried to exploit it with hundreds of millions if not billions of dollars. When that happens, the strategy no longer works. Charles Ellis, in his book "Winning the Loser's Game" develops this theme, arguing that all the bright people in the business basically cancel each other out, leaving us with random walks.

Right it cannot be done. But I have been at this sort of thing for years. The devil is is in the details.

[bobandsherry]

Data points not known for 6 months kinda makes this a non-starter. But understand how it can be fun. Thanks for sharing.

[Lsbcal]

Quote:

Originally Posted by bobandsherry Data points not known for 6 months kinda makes this a non-starter. But understand how it can be fun. Thanks for sharing.

That is 6 weeks, not months. And the results posted are with that taken into account. Monthly strategies are easier to implement.

[bobandsherry]

Quote:

Originally Posted by Lsbcal That is 6 weeks, not months. And the results posted are with that taken into account. Monthly strategies are easier to implement.

Yep, I knew it was 6 weeks, and still typed 6 months.

[NW-Bound]

Quote:

Originally Posted by Lsbcal I'm impressed at the low response rate. Maybe I should have been more provocative? Or maybe people aren't interested in "chicken little" switch strategies? I've allocated 10% to a version of this strategy. I figure on getting better then bond returns on this slice with very moderate equity risk. Still I will have to accept the occasional scary downdrafts that do not last but a few months (as opposed to recession/depression scenarios).

Why do you want more people to adopt this? It would stop working, you know?

By the way, I did not zoom in to see closer, but the leading indicators do not seem to be leading the stock market all that much, and are more like coincident indicators with the market.

Perhaps it is because these indicators lead the state of the economy, which the stock market also does. In that case, they are not of help in predicting the market movement.

[Lsbcal]

I think the point here is to get the bulk of the bull market but be willing to take a somewhat lower return. Still better than bonds. The data shows one can avoid the worst of recessionary declines. The data does not show all short term declines are avoided. Of course, there are only 3 recessions shown. And only 36 years.

I am not trying to get anyone to adopt this strategy. Just looking to test out the idea. With hopefully thoughtful posts. This is not intended to take the place of most of one's AA.

[Lsbcal]

Quote:

Originally Posted by NW-Bound ... Perhaps it is because these indicators lead the state of the economy, which the stock market also does. In that case, they are not of help in predicting the market movement.

If you look closely at the data, you find that the stock market declines are associated with even lower levels of the US Leading Index then the 1.2 value I mentioned above in the simulation data. For instance, the market high in November 2007 was seen with the Leading Index at 0.43 (note: one would have been reacting to the August 2007 index value of 0.56). One would have been out of the SP500 way before the 2008 declines. But this is by design as the bond market is the bogey for this strategy.

Also the 1.2 value can be triggered without leading to a long term move into Treasuries. For instance, in September 2017 these indicators fell to 1.11 temporarily before bouncing back. So one would miss about a 4.9% up move in the SP500 if staying in Treasuries for 3 months. That is the price one pays for doing these kinds of things. Not a problem if one is only trying to beat bonds.

[joeea]

Quote:

Originally Posted by Lsbcal Or maybe people aren't interested in "chicken little" switch strategies?

I suppose I'm one of those people.