Combine Market Trend and Economic Trend Signals?

A subscriber requested review of an analysis concluding that combining economic trend and market trend signals enhances market timing performance. Specifically, per the example in the referenced analysis, we look at combining:

• The 10-month simple moving average (SMA10) for the broad U.S. stock market. The trend is positive (negative) when the market is above (below) its SMA10.
• The 12-month simple moving average (SMA12) for the U.S. unemployment rate (UR). The trend is positive (negative) when UR is below (above) its SMA12.

We consider scenarios when the stock market trend is positive, the UR trend is positive, either trend is positive or both trends are positive. We consider two samples: (1) dividend-adjusted SPDR S&P 500 (SPY) since inception at the end of January 1993 (nearly 26 years); and, (2) the S&P 500 Index (SP500) since January 1948 (limited by UR availability), adjusted monthly by estimated dividends from the Shiller dataset, for longer-term robustness tests (nearly 71 years). Per the referenced analysis, we use the seasonally adjusted civilian UR, which comes ultimately from the Bureau of Labor Statistics (BLS). BLS generally releases UR monthly within a few days after the end of the measured month. We make the simplifying assumptions that UR for a given month is available for SMA12 calculation and signal execution at the market close for that same month. When not in the stock market, we assume return on cash from the broker is the yield on 3-month U.S. Treasury bills (T-bill). We focus on gross compound annual growth rate (CAGR), maximum drawdown (MaxDD) and annual Sharpe ratio as key performance metrics. We use the average monthly T-bill yield during a year as the risk-free rate for that year in Sharpe ratio calculations. While we do not apply any stocks-cash switching frictions or tax considerations, we do calculate the number of switches for each scenario. Using specified monthly data through September 2019, we find that: (more…)