Regime Driven Mean Reversion

Jun 10, 2020 in mean reversion | Regime Change

Late last year we produced a video that showed how two different strategies, relative strength and mean reversion, could be layered on top of each other.  That example went through each of the constituent backtests separately, in order to explain the mechanics of the process.

The example below shows how such a dual-layered strategy can be run in a single backtest.  The first layer employs the SPY / VEU ratio moving average as a regime switch to dynamically alternate between whichever is stronger; U.S. or International stocks.  Then, the second layer picks the weakest short-term performer within that chosen asset class.

To keep it simple, we have used the same basic U.S. (MDY, IWM, SPY and QQQ) and international (EWA, EWC, EWH and EWS) ETFs that we have used in previous examples.

 

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Layering 2 ETF Backtest Strategies For Enhancing Return

Dec 16, 2019 in mean reversion | Regime Change | Video

Layering 2 strategies on top of each other for better return -- and importantly this can improve the consistency on a year-to-year basis. The mean reversion strategies tend to add more return when things are volatile -- but less relative to the benchmark when the market is rising on low volatility. That said, low volatility uptrends are often an excellent environment for absolute gains anyway and you will naturally participate in such a market because mean-reversion has zero market timing associated with it. That is, sometimes you will just track rather than outperform a low-volatility uptrend.... and that is a good thing.

 

 

 

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Strategy Diversification: Combine a core allocation with regime based portfolio switching

May 07, 2019 in Regime Change

Back in 2010 we created our first multiple strategy module, the Advanced Relative Strength backtest, allowing subscribers to combine together different models into an overall portfolio.  To illustrate the backtest, we produced a simple example that employed two sub-strategies; a basic US equity model (MDY, IWM, SPY and QQQ) and an international model using smaller developed country funds (EWA, EWC, EWH and EWS).

The example below uses the same ETFs as that original illustration, but this time, rather than running each model concurrently, we have employed the SPY / EFA ratio moving average as a regime switch to dynamically alternate between the two portfolios.  When the SPY / EFA ratio is trending upwards (i.e. above its MA), the backtest invests in the US equity portfolio.  When the opposite is true, it switches to the International stock portfolio.  This regime approach is then mixed with a solid fixed income core portfolio (IEF and LQD) to form an annually rebalanced 60-40 strategy.

 


The Core-Regime Portfolios backtest is available to pro subscription members

 

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Regime Change Backtest Example

Apr 24, 2019 in Regime Change

Regime Change is used in finance to describe when a condition changes.   IF [condition1] is met,  THEN invest in [X]...   ELSE invest in [Y].   ETFs allow us to easily test conditions which are defined not by some calculation you've created to simulate an index,  these are publicly traded securities with real money invested in them.  There is no ambiguity as to the rules when you use real-world securities as is so often the case with non-financial regime tests.  

Here is a simple example to get the hang of it, is the NASDAQ-100 going up?  If it is, buy it.  If it isn't, invest in a different type of ETF.   In this example, the different type of ETF is defined by the QUALITY FACTOR.   Quality stocks are those with strong balance sheets, lower earnings variability & higher Return On Equity -- as ranked by indexing firm MSCI.   QUAL actually owned real stocks on each day with real money, we aren't subjectively now determining what should be classified as quality and what shouldn't.

What does the performance report look like for this idea?  See below for summary version of an ETFreplay.com backtest report  (statistical analysis excluded in image below).

Then try other ideas.   All of your ideas don't have to work for you to be very successful at this.   Indeed, this strategy has underfperformed its benchmark 46% of the time in last 5 years (as measured by relative performance in each calendar month).  Yet the outperformance over time has been good.

 

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Jan 31, 2019 ETFreplay Market-Generated Information (MGI) Report ETF Backtest

Jan 31, 2019 in Ratio | Regime Change

 Jan 31, 2019  ETFreplay Market-Generated Information (MGI) Report

Focus on using TIPS index as a backtest parameter for Energy Stocks (XLE)

(Click on Image For Link to PDF)

 

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Example of the Core - Regime Relative Strength ETF Backtest Module

Jul 26, 2018 in Regime Change | Video

A video with a demonstration of the new Core-Regime RS Backtest module. The public video below uses the following subscriber-only backtest ETFreplay Core - Regime Relative Strength Backtest

 

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Video: ETF Regime Portfolios Backtest (Weekly) Using High-Yield Bonds

Mar 20, 2018 in Regime Change | Video

A video using the Regime Portfolios Backtest to check-in on using high-yield bonds as information into the state of the market.

 

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Video: Practical Starter Improvements Upon Absolute Return / Cash Filter Strategies

Feb 15, 2018 in Regime Change | Video

A ~5 minute video using the Regime Relative Strength Backtest to look at some parts of an Absolute Return strategy and ways to improve upon it.

 

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Indexes Change Over Time. Recent Data Is More Important Than Long-Term Data. It just is.

Jan 18, 2018 in Regime Change | S&P 500

An index can change rather importantly over time.  Some segments go through sustained secular performance and become increasingly important on a secular basis.   This has happened with the internet relative to much older industries.  Sometimes it can be a bubble but for every time someone calls something irrational, there are many cases where something secular is happening.

Below is a chart plotting how much more important Amazon.com is to the performance of the S&P 500 than it used to be.  This has come at the expense of names like Exxon. 

Another example is Facebook vs Chevron.

 

To look at a different part of the world, think about how important China Mobile used to be vs where it is now and how Alibaba Group was 0% and now its the 2nd largest holding in the S&P China Index.

 

Think about what this does to fundamental ratios like P/E's and dividend yields on the index aggregates.  Exxon pays a large dividend -- AMZN and FB don't pay anything in dividends.   Exxons P/E in 2007 was under 13x while the AMZN P/E has averaged well into the triple digits over the past 10 years.

This is loosely related to 'Regime Change' -- the fundamentals of backtesting are that you should think about RECENT DATA and weight it more heavily than old data.    Same concept.  What the P/E was 10 years ago isn't very important  And what it was 30 years ago is less important than that. We do NOT mean to imply 'this time is different'. We are simply saying weight more recent times more highly than you do data from 100 years ago.   

See also:

Regime Change Backtesting

 

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A Backtest Example For Inspiration: EFA vs QQQ regime

Oct 06, 2017 in Regime Change

This backtest defines a Regime by comparing the performance of EFA and QQQ, two standard ETFs with plenty of market cap. The backtest then decides to allocate to EFA or QQQ depending on which Regime is in place. SPY is held in either case as a core position:

 

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