4/3/2019 Philosophical Economics' Growth-Trend Timing - AllocateSmartly

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Philosophical Economics’ Growth-

Trend Timing
APRIL 5, 2017

This is a test of the Growth-Trend Timing (GTT) model from the always thought-provoking
Philosophical Economics. GTT combines trends in price and key economic indicators to switch
between US equities and cash. Results from 1970, net of transaction costs, follow.

Read more about our backtests or let AllocateSmartly help you follow this strategy in near real-time.

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Logarithmically-scaled. Click for linearly-scaled chart.

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If you don’t follow Philosophical Economics, I highly recommend that you do so now. Where PE
di ers from other authors is an extreme focus on the mechanics that underlie strategies, as opposed
to simply (potentially over t) results. The source piece for this strategy is a masterwork in
understanding trend-following.

A key takeaway is that trend-following strategies based on price alone do a good job determining
when to switch to defensive assets inside of recessions, but a poor job outside of recessions. If we
have a means to judge when the economy is entering/exiting a recessionary period, we’ll know when

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to turn trend-following on/o . PE uses two key economic indicators that have been strongly
predictive of past recessions to make that determination.

Strategy rules tested:

At the close on the last trading day of the month, calculate the year over year change in Real
Retail and Food Services Sales (RRSFS, a measure of economic consumption) and the
Industrial Production Index (INDPRO, a measure of economic production) as of the end of the
previous month. The one month lag is required due to the delay in the reporting of these
numbers.

If the YOY change in both indicators is positive, go long the S&P 500 (represented by SPY) at
the close. In other words, no recession is signaled, so turn trend-following o .

If the YOY change of either indicator is negative, compare the S&P 500 (SPY) to its 10-month
moving average. If the S&P 500 will close above the average, go long SPY at the close,
otherwise move to cash. In other words, possible recession is signaled, so rely on price to
con rm. Note that this is the same trend-following rule used in Meb Faber’s classic GTAA.

Hold positions until the nal trading day of the following month.

Why not just base the entire strategy on the economic indicators? Because they often signal
weakness too early. The price-based indicator is required to con rm that weakness. To illustrate,
below we test other variations of the strategy, based on each component of the strategy in isolation:

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Note the superior performance of GTT’s combined approach, and the signi cant increase in time
spent in the market. The di erence between GTT and RRSFS/INDPRO is even more pronounced in
Philosophical Economics’ longer test.

This strategy is unlike most that we track, in that it only switches between two assets: the S&P 500
and cash. Because I know that readers will ask: had we replaced cash exposure with US Treasuries
(represented by IEF) or a US Aggregate index (AGG), strategy returns would have increased by 1.0%
and 0.9% per year respectively. Of course, given current rates, it’s debatable as to how relevant that
is to today’s market.

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It would be very interesting to see this concept expanded to include other asset classes, each with
their own relevant economic indicators, in order to create a more diversi ed portfolio. Philosophical
Economics’ observation regarding how price-based trend-following is a ected by the state of the
economy is an important one that I’d like to explore further. Expect to see more strategies that make
use of fundamental data like this added to Allocate Smartly in the coming months.

Thank you to Philosophical Economics for all of their ne work and for the opportunity to put this
model to the test. For readers interested in thorough, empirically-oriented, outside-the-box thinking
on investing, I highly recommend following Philosophical Economics now.

We invite you to become a member for less than $1 a day, or take our platform for a test drive with a
free limited membership. Members can track the industry’s best tactical asset allocation strategies in

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near real-time, and combine them into custom portfolios. Have questions? Learn more about what
we do, check out our FAQs or contact us.

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