Research Excerpts

Introducing Our Updated Correction Protection Model (CPM)

Posted on: Wednesday, May 29th, 2019

Introduction

In 2013 we introduced our Correction Protection Model (CPM) to Asbury Research subscribers, which we had back-tested to 2007.  That model did an outstanding job of essentially avoiding the entire 2008 Financial Crisis, and subsequently performed well in real time by simply staying invested during market advances and moving to cash during market declines.

However, the character of the market has changed over the past several years (as it typically does over time) due to a number of factors including quantitative easing, a more accommodative central bank policy, and the fact that 70% of daily stock market volume is now attributable to algorithmic trading.  In our view, these factors have resulted in more sustained market advances, smaller, quicker market declines, and more choppy and erratic day-to-day price movement.

Although our original 2013 CPM entries have continued to perform very well in the current environment, the exits have become less effective.  Because of this, in early 2019 we began working on updating and improving CPM.

This newly updated version of CPM, which has been back-tested to 2011, has the exact same purpose of the original version.  It is a defensive model with the primary objective of protecting investor assets during adverse market conditions, but otherwise remaining invested to take advantage of the market’s historical propensity to move higher over time.

Here are the details.

CPM’s Purpose & Key Features

  • Protects investors against significant market declines
  • without sacrificing long term performance, under a variety of market conditions,
  • all while greatly reducing market risk as measured by actual time invested and by volatility of returns.

More About CPM

  • CPM is binary.  It is either Risk On (invested in the market) or Risk Off (out of the market).  There are no short positions, leveraged longs, or hedging via derivatives.
  • CPM is not a returns-driven model. It was designed to protect investor assets during adverse market conditions while taking advantage of the market’s historical propensity to move higher over time.
  • CPM utilizes 3 quantitative inputs.
  • CPM uses the S&P 500 as a proxy for the market.

Performance Highlights.  Since 2011:

  • CPM has averaged 5 signals per year.
  • CPM has only been in the market 64% of the time, significantly reducing risk.
  • Table 1 below shows that CPM has outperformed the S&P 500 4 of the past 8 years.

    Table 1

  • Table 2 below shows CPM’s maximum drawdown (over a rolling 90-day period) has been 9.5% versus 17.9% for the S&P 500, which is 47% less.
  • Table 2 also shows CPM’s implied volatility has been 4.45% versus 5.91% for the S&P 500, which means CPM has been 25% less risky.

    Table 2

  • The chart below plots the daily performance in index points for both CPM and SPX from January 2011 through May 2019, showing that CPM has outperformed SPX by 273 index points or 9.9% during this period.

Chart 1

Click on tables and charts above to enlarge

The Bottom Line

Since 2011, CPM has:

  • outperformed the S&P 500 (SPX),
  • reduced the time invested in the market by 36%,
  • reduced the maximum drawdown in SPX by 47%, and
  • reduced the volatility of market returns (implied volatility) by 25%.

Simply stated, CPM provides Asbury Research subscribers with a methodology to participate in US stock market advances while significantly reducing market exposure and market risk during stock market declines.

 

Disclaimer: All investment models have inherent limitations in that they look back over previous data but can’t see into the future, and CPM is no different. Past performance does not guarantee future results.  These limitations aside, however, our model argues against the buy and hold “strategy” and the assertion by its proponents that “you can’t time the market” or “you can’t beat the market”.

Attempting to get out of the way of an emerging market decline comes with the inherent risk of potentially missing out on some performance — especially considering the current “buy the dip” mentality engendered by a decade of stimulative Federal Reserve policy.  However, our model’s performance is a testament to intelligent quantitative risk management, showing that a conservative, systematic, and repeatable process of active management can over time significantly outperform passive buy and hold.

This data is provided for information purposes only. Past performance or back-tested results may not necessarily indicate future results. The performance indicated from back-testing or historical track record may not be typical of future performance. No inferences may be made and no guarantees of profitability are being stated by Asbury Research LLC. The risk of loss trading in financial assets can be substantial. Therefore, you should therefore carefully consider whether such trading is suitable for you in light of your financial condition.


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