Switch at the highs – Meb Faber

Today’s post looks at a paper from Meb Faber called All Time Highs.
Contents
All-Time Highs
Meb Faber is very familiar to us as the owner of Cambria Investments.
- He’s written some great (and easy to follow) white papers, and his firm offers a lot of interesting ETFs (only available in the US, sadly).
I’m not sure when the paper came out, but it uses data up to 2019, so I’m going to guess at some time during 2020.
It looks at the idea of investing at (or near) all-time highs, which turns out to be a great idea.
Each month, you check to see if an asset is within 5% of its all-time high. If it is, you either buy the asset (if you didn’t already own the asset based on the prior month), or you continue owning the asset. If the asset class doesn’t meet this “all-time high” hurdle, you invest your capital in the relative safety of 10-year US government bonds.
For US stocks from 1926 to 2019, this returns 9.6%, compared to 10.0% for buy and hold.
- But the volatility is 11% instead of 19%, and the Sharp ratio is 0.57 instead of 0.36.#
Best of all, the max drawdown is only 29% instead of 84% (during the Depression).
It works for international stocks, too – this time with a higher return than buy and hold.
And it works for a 50:50 mix of US and international stocks.
12-month highs
Since it’s not practical to wait around for all-time highs, Meb tweaks the system to invest when within 5% of all-time highs.
Things still look good.
It looks even better with foreign stocks.
And great for the 50:50 mix of US and international.
Since 1972
In an attempt to be even more persuasive, Meb looks at more assets, using more recent data (1972 to 2019).
US stocks look good.
Foreign stocks look good.
Commodities look good.
Real Estate looks good.
Gold looks good.
And finally, an aggregate portfolio split equally between each of the asset classes looks really good.
Great not new
This is a great system, but Meb admits that it’s not a new one.
This is a channel breakout system. It’s been around since the time of Donchian and likely much longer. For a fun read on this topic check out the book “How I made $2,000,000 in the Stock Market” by Nicolas Darvas.
It’s also very similar to a moving average trend-following system, which Meb described in another paper and his book The Ivy Portfolio.
Equally as important – you’re NOT following the downtrend of falling stock prices.
Nor is the system psychologically easy to follow:
Many investors fear buying at recent or all-time highs. It can feel like you’re chasing performance or showing up at the party just a few minutes before the hosts kick everyone out.
And it has underperformed buy and hold since the 2008 crash (since when we’ve had low interest rates and US tech stock dominance).
Despite this, Meb recommends some form of trend-following, ideally combined with buy-and-hold (as in his Trinity Portfolio).
- Which sounds pretty good to me.
Allocate Smartly
In March 2024, Allocate Smartly (AS) – one of the best Tactical Asset Allocation (TAA) websites – ran a backtest of Meb’s 12-Month High Switch.
Like me, they are big fans of Meb:
Meb has done more than anyone to popularize TAA as a trading style, including many of the fundamental concepts used today. This is another of his simple but effective ideas. We can’t say enough positive things about the impact Meb has had on TAA. He’s one of the good guys.
Their test period was from 1970 to 2023, and transaction costs are included. As before, they used five asset classes:
The S&P 500 (represented by the ETF SPY), international equities (EFA), US real estate (VNQ), gold (GLD) and commodities (PDBC). Any portion of the portfolio not allocated to one of the five asset classes above will instead be placed in intermediate-term US Treasuries (IEF).
The strategy still looks good.
It looks even better on a chart with a linear rather than a logarithmic scale.
We have better returns and Sharpe, lower volatility and shorter and shallower max drawdowns.
Asset classes
AS also looked at the individual asset classes:
In most cases, only trading near 12-month highs would have reduced total return – usually by a small margin. In exchange however, it would have significantly reduced drawdowns and improved risk-adjusted performance (ex. Sharpe Ratio).
This helps psychologically (investors are more likely to stick with a smoother ride) and provides for a higher SWR in retirement.
Dynamic bonds
Since the 2022 crash, when stocks and bonds fell together, AS has taken to describing the use of long bonds as a safe asset as a “fatal flaw”.
- They fix this by applying the same logic used for risk assets within a strategy to the defensive assets.
For this strategy, that means we only go long US Treasuries (IEF) if they too are within 5% of a 12-month high, otherwise we shift to cash.
For AS, “cash” is the 3-month Treasury return.
For this strategy, the dynamic bond version is close to the standard variety.
Most of the stats are very similar.
The only time an investor would have noticed the difference would be in 2022 when the dynamic bond version only fell by 5.5% instead of 13.2%
Conclusions
AS likes the strategy:
This is a simple, straightforward, effective approach to TAA. Yes, it’s essentially trend-following and exhibits high correlation to other “classic” tactical strategies we track. This strategy may be worth considering as a component of a diversified Model Portfolio.
I also like the strategy and will be allocating part of my portfolio to a variation on it (most likely with more asset classes).
- I also plan to revisit this idea in combination with classic momentum in a later article.
Until next time.