BACKGROUND MATERIAL --> | Prime Rate Market Timing Model | Trendex Market Timing Model |

SEE ALSO --> | PowerStocks Composite SUPERModel Market Timing System |

We have shown how changes to the Prime repo rate can be an important indicator for a market entry/exit investment timing strategy, delivering 45,570% gains if used on the ALSH index over the last 32 years, by only being in the stock market 50% of the time (significantly less risk than a buy-and-hold investment strategy.)

We also showed how powerful the Coppock/Trendex Indicator proved over the last 32 years in a similar switching strategy that delivered 55,667% growth over the 32 year period by only being in the stock market an amazing 40% of the time.

What if we were to combine these two indicators into a single market-timing model? The below chart compares the Repo rate models' timing signals to the Trendex models' timing signals over the last 32 years. Click on the image to load a larger version (right click to download)



We noticed that the Repo model excluded us from a nice bull run from 1988 to 1991, when the markets were going up in tandem with interest rates, straight after a massive crash (remember, the interest rate model kept us out the market when the repo rate is rising). Whilst the Repo model keeps us out of big bear markets, it does miss out on some of their recoveries when gains can be spectacular. But this is exactly where the Trendex model excels - big bear market recoveries! Also the Trendex model missed a nice 95% bull run from 1985 to 1987 which was not built off a crash, hence no Trendex BUY signal was ever generated. So it seems the two models could complement each other nicely.

Other observations from the above chart are that the entry and exit signals for the 2003-2006 bull run were almost identical, similarly the 2009 buy signals differ by only 5 months (December 2008 for Repo model and May 2009 for the Trendex model.) Also some buy and some sell signals for both models were very close on some occasions.

The "TrendexPrime" Combined Timing Model
After back-testing various combinations of the two timing models, the best combined Prime Rate and Trendex model, which we will call TrendexPrime for now, has the following simple rules:
 
  1. Track both the PowerStocks MPI and the Trendex Indicators
  2. The first Indicator to trigger a BUY gives your ENTRY signal
  3. The first to trigger a SELL gives your EXIT signal
  4. Once a BUY is triggered, ignore any other BUY signal and look for a SELL signal. Similarly, once a SELL is triggered, look for the next BUY and ignore any other SELL signal.


The charts above show the performance of this strategy (assuming you bought an Index Tracker to invest in the market) versus the ALSH buy-and-hold and the Repo (INT RATE) and Trendex (TDEX) timing strategies. We observed that the Repo rate strategy formed the core of the signals, but Trendex allowed us to participate in some crash recoveries where interest rates were still rising and also allowed for more profitable (but shorter trades) during some periods. There are a few more transactions with this strategy, totalling 1.4 years per transaction as shown in the below transaction list :




Interesting points to note here are that the average period invested in the market was 15.4 months and the average period invested in the bank or money markets was 16.8 months. In 12 periods we were invested in the JSE, we only suffered losses twice (16.7% of the time) and those were limited to -1% and -4% respectively. Note that the average JSE growth experienced while our money was tucked away in the bank or other fixed interest instruments was a paltry 0.8%. Note from the table that EVERY period our money was in the bank/fixed deposit or money markets, we outperformed the ALSH significantly.

It seems the combined Repo/Trendex model is VERY effective in determining which are the best periods to have money in the stock markets and which are the best periods to have money in the bank!

The table below makes a summary comparison of the 32 year performance of the TrendexPrime Market Timing strategy versus all others looked at so far. In a nutshell, the introduction of the Trendex timing indicator to the Repo rate model boosted growth by 10,500% by staying slightly less time in the stock market and introducing 2 more transactions.

 

TrendexPrime Model Portfolio
We will be incorporating TrendexPrime into our PITBULL Market Timing System under the PITBULL Ver 2.0 nomenclature. We will continue to build upon PITBULL until we have reached that mechanical investors dream - 25% CAGR over 32 years.

We will also maintain and track the live performance of a TrendexPrime Model Portfolio incepted on 25 April 2000 using the Satrix40 ETF as ALSH proxy (the Satrix ETF was only listed in 2000). The current performance of this model portfolio, dubbed "TDXPRI-STX40" as at 18th June 2009 is shown below. The light blue shaded areas represent times we were "out the market" with our funds earning prime less 4% interest.



As you can see, JSE returns during the blue shaded areas was not only gut-wrenchingly volatile but also finished up rather anaemic (18.8% in the 1st period versus 43.5% we earned in interest, and 16% in 2nd period versus 29.7% we earned in interest.) The strategy is convincingly out-performing the ALSH across all periods as shown below (as at 18 June 2009.)



The above performance is rather remarkable, given that since inception the model portfolio has only been vested in the stock market a total of 38% of the time (a total of 42 months out of an elapsed 110 months). Also, the period we were invested in the stock market was just on 36 months which meant we would only have incurred capital gains taxes on JSE returns as opposed to income taxes at our marginal rates.

We will publish the ongoing performance of TDXPRI-STX40 on our SCOREBOARD page along with all the other investment strategies we track.

Improving performance even more
There are a number of ways you could improve performance of your strategy.

Interest Earned

We used the daily published Prime Rate less 4% for our daily interest rate calculations during non-vested periods. Depending on the amount of your funds you might be able to do much better than this in the money markets or through your private banking account, which would boost returns of the strategy even further. Even a 0.5% better rate, compounded over 30 months makes a huge difference to returns.

Delayed Exit Signals
We have seen that the Interest Rate Timing model and the Trendex Timing model are VERY CONSERVATIVE strategies, both erring on the side of caution by getting us out early when markets become "risky". Since TrendexPrime is a combination of these two timing models, it suffers from the same cautionary bias. On many occasions over the 31 year test periods these models "pulled the SELL trigger" earlier than desired, while the markets were still in their "irrational exuberance" phases.

It would have been tough for the investor sitting on the sidelines during these periods.
You can see that the strategy pulled the plug on 8 June 2006 and the JSE had a fantastic 71% growth run for a further 12 months to July 2007 before it started firing its first "warning shots" (increased volatility and declining breadth). During this growth spurt, we only earned 10.29% interest . Whilst in hindsight it is easy to lament this early exit, there are some occasions in the 31 year backtest when these early exit signals actually saved our capital from devastating losses (of up to 40-50%). All it would have taken is one 25% to 40%hit in a market crash early on in our investment journey to cripple the strategy returns for decades to come.

However, when a SELL signal fires, you could enhance returns by switching to tracking a 100 day moving average and only selling when the Index drops below this.  Our feeling though is that this defeats the "low maintenance" objective of these strategies and possibly leaves too much to chance.

Using a better performing Index
Another way to enhance returns significantly is to use a better performing index than the ALSH. We showed previously with our RiskCurves Probability Models research that we could create a 5-share "index" we dubbed BLUECHIP that closely mirrors the movement of the JSE but significantly out-performs it. What if we applied the TrendexPrime timing system to this "index"? Our expectations were confirmed - you could significantly improve performance in this manner. TDXPRI-BLUE is the timing strategy performed on the BLUECHIP portfolio and solidly outperformed the Satrix40 ETF timing strategy. It is incredible to note that even when "in the bank" from mid 2006 to 2008, when the JSE was in irrational exuberance mode, that TDXPRI-BLUECHIP was actually equalling the performance of the JSE!



Predicting Repo-Rate changes
We noted in our backtests that when a raise in interest rates triggers a SELL, the JSE seems to experience a severe fall-back (see the above chart) in some instances. We have used the Reserve Bank published date for these signals in the backtests but with a bit of effort you could probably predict what the next Monetary Policy Committee (MPC) Meeting is going to come up with and time your exits early to avoid these drop-off's. Just monitor the press and analyst predictions in the lead-up to the MPC meeting. For example, had you done this with the June 2006 initial interest rate hike, you would have spared the portfolio a 15% decline before we switched into the bank acounts. This can enhance returns significantly. Similarly predicting initial rate drops, when the market is in a bottoming phase just waiting for some good news can get you in early and also enhance returns. 

Other measures
In PITBULL Ver 3.0 we are introducing further timing signals coupled with the TrendexPrime strategy that can be used to minimise the "loss of potential gains" of these early exits, and capitalise on these "last gasp" bull market runs whilst still ensuring we STAY WELL CLEAR OF MARKET CRASHES which can cripple our portfolio returns for decades to come.

Testing so far has shown that PITBULL Ver 3.0 (Beta) delivered a stunning 75,000% growth (24% CAGR) over the 31 year test period versus the 66,000% (23.49 CAGR) delivered by TrendexPrime, whilst only being in the market 55% of the time.
 
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