Tactical Asset Allocation Based on the Yield Curve

I spend a lot of time talking about asset allocation on the blog.  I’ve presented quant systems that focus on price based tactical asset allocation, cross-market momentum strategies, and mean reversion strategies (just to name a few).  Some older posts are:

A Quantitative Approach To Tactical Asset Allocation

Asset Class Rotation

Mean Reversion After Really Bad Months

Asset Class Returns Based on Fed Policy

Inflation and Asset Class Returns

Sector Rotation with Hedging

I was originally going to put this out as a white paper, but seeing that I have about 5 of those on the back burner (and this seems to be a pretty well known property), I thought a simple blog post would do.

Below we examine the effects of the yield curve on our group of asset classes.

(Data sources: Global Financial Data)

US Stocks – S&P 500

Foreign Stocks – MSCI EAFE

Bonds – 30 Year US Govt

Commodities – GSCI

REITs – NAREIT

Spot Gold

Buy and Hold is an equally-weighted, monthly rebalanced allocation to the above 6 asset classes.

First, we examine how the 10 year US Govt Bond – 90 Day Tbill rate affects the return of various asset classes.  We selected three modes, but by no means are these optimized or optimal. The table below presents the % of time spent in each mode, as well as the annualized returns for the annualized returns for the asset classes.

yield

One could devise a simple timing system based on these properties.

When the yield curve is <0%, long commodities and gold.

When the yield curve is 0 – 2%, long us and foreign stocks.

When the yield curve is >2%, long bonds and REITs.

This simple system would have beaten buy and hold by over 4% a year over the time period with more volatility (mostly upside) and a similar drawdown.  Equity curve below:

rotat

And since you asked, here’s the chart with the momentum rotation system added with a simpler combo of both too:

combo

 
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