Logical Invest strategy update for an inflation environment.

The following strategy update will be in effective for the February rebalancing. QuantTrader user will get a notice of the updated QuantTrader.ini strategy file when they start QuantTrader. You can also download the file also manually from here: https://logical-invest.com/quanttrader/QuantTrader.ini

It is my opinion that going forward, inflation poses a serious risk for investors. From 1980 to 2015 Inflation went down from more than 10% to near 0%. Since 2015 inflation is steadily rising from nearly 0% to now more than 2%. Inflation is a bond’s worst enemy. Since we use Treasuries to hedge our strategies, rising inflation may have a very negative impact on our TLT Treasury ETF positions.

It is not just bonds. Inflation could negatively impact the equity markets as well. Many U.S. companies are running on cheap credit and are deeply in dept. The Russell 2000 small caps, in aggregate, have already negative earnings today. Higher credit costs due to inflation would mean the end of many of these companies, resulting in a strong market correction. All this could mean that stocks and bonds go down together which would negatively affect our strategies.

One solution to this is to use Gold. Gold has always been one of the best hedges against inflation. So I decided to use it and build a more universal, “inflation-proof” hedge.

The Hedge strategy

This Hedge is now a separate strategy called “Hedge”. It is composed by TLT, the long term Treasury bond and a slightly redesigned GLD-USD strategy.

The new Hedge did perform quite well in the past and can be used profitably as a standalone strategy. This is an advantage for the strategies which use it as a hedge. Most of the time the “Hedge” gets about a 50% allocation within the strategy, and so we are much better prepared for unforeseeable “black swan” events.

The updated GLD-USD strategy

The “GLD-USD” strategy now uses two sub-strategies. The backtests show it would have performed much better during the last 10 years. The strategy is composed, in equal parts, of two different GLD-USD sub-strategies.

One is an aggressive GLD-USD strategy and the other a low volatility GLD-USD strategy. Using two sub-strategies, we can better adjust the EUR/YEN/AUD currency protection and avoid the over-protection we had last year.

The updated GMRS – hedged strategy

The updated Global Market Rotation strategy has been simplified by removing all the currency-hedged ETFs. We now have a natural currency hedge incorporated in GLD-USD strategy inside our main Hedge.

In an effort to better control risk, the strategy now limits the maximum allocation to more volatile markets ETFs, like the Latin American ETF.

The performance of the new strategy is better, and draw-downs are reduced.

The updated GSRS – hedged strategy

The updated Global Sector Rotation Strategy has been modified by splitting the sector strategy in two sub-strategies. One selects safe low volatility sectors while the other is more aggressive, uses a shorter lookback period and selects faster growing, smaller sectors. These two sub-strategies are combined with the Hedge strategy which adds a performance improvement as well as a much lower maximum drawdown.

The updated UIS – hedged strategy

The updated Universal Investment Strategy has been adapted by replacing the Treasury hedge with the new Hedge strategy. I must admit that the strategy now looks very similar to the classic SPY-TLT-GLD Permanent Portfolio strategy, but this only shows that going forward, GLD has a good probability to work well as an inflation hedge.

The new UIS strategy also had a better performance in the past than the original strategy, even with GLD added, in spite of  Gold being a bad investment for past 10 years.

The updated World Top4 – hedged strategy

The risk of the old strategy was that it mixed together and weighted all countries equally. This could result in the strategy being invested in small volatile countries. This led to some painful corrections in the past.

The new strategy builds from 4 sub-strategies: Developed countries, Asia, Africa and South America. The maximum allocation is limited for each sub-strategy, which results in a better mix of stable, low-volatility larger countries vs better performing and volatile smaller ones.

The strategy did much better than the old one and the maximum drawdown was much lower due to the maximum allocation limitations.

Overview of the Strategies

The backtest covers about 8 years. It is limited by of the EUR/YEN/AUD currency ETFs used in the Hedge strategy. I have also made backtests for up to 20 years using a similar Hedge strategy without these currency ETFs. This way the Hedge strategy did not perform as good as the currency hedged strategy, but still the results of all strategies are better than the original strategies.

Finally, I hope that going forward the strategies will be better protected against an inflationary environment.

The MYRS and Nasdaq100 strategy have not been updated. They still use the 3x leveraged TLT hedge which fits better to the high volatility of the single Nasdaq 100 stocks. You can however replace TMF by 3x the allocation of the Hedge strategy.

For the Nasdaq100 strategy I have updated the list of the 100 stocks included.

The US sector strategy has not been modified, as this strategy hedges by shorting an industry sector. This is something which should also work if there is inflation.