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Portfolio Protection Strategy

​Lighthouse Financial offers its clients a Tactical Overlay at no cost. It is not a trading strategy but an indicator that can tell us when it is dangerous to be in the market and when it is safe to be in growth mode. 

Back Testing
The only way to test the validity of any indicator like this is to run longer-term back tests to see how the indicator would do under different environments. For the sake of simplicity, we ran a back test on this indicator and used a proxy for the S&P 500 which is SPY. SPY is an ETF (exchange-traded fund) that mirrors the S&P 500 index, and the bond proxy is TLT which is a long-term treasury ETF. We do not offer any suggestions to invest in SPY or TLT. This back test simply compares the long term performance of SPY versus the long term performance of SPY with the indicator. 

The Tactical Overlay can also allow us an opportunity to introduce a different kind of diversification. Linear diversification is linear by time and is not necessarily the broad diversification that comes from holding a basket of positions with multiple asset classes represented. Even though this Overlay uses SPY on both sides of the comparison, it has a very low correlation (<15%) to the markets and will not line up with the market performance on a monthly or even yearly basis. 

Our Tactical Overlay is simply a signal that can be applied to any of our investment strategies. Once applied, it can limit our downside risk. It is unique in that it looks at consumer spending to determine when we should take risk off the table. Specifically, we came up with a ratio built off of Consumer Staple versus Consumer Discretionary spending. This ratio is tracked against its moving average. When the ratio drops below its moving average (checked every month), it signals us to exit risk and possibly get into more bonds. Part of the Tactical Overlay also looks at the bond market to see which, if any of the 10 bond sectors we track are positive. Of course, there is always the freedom to learn and improve the Tactical Overlay. 

There are many factors not included in this back test that we should all be aware of:
The results do not include any advisory fees that we would be charging clients all along.
The results do not factor in any re-investment of dividends or earnings.
The results are backward looking and have the advantage of hind site which allows us to change the indicator over time. We have changed how the indicator works and results are quite different than if we had started and ended with the same parameters. 
We are excited to announce that, out of all the technical indicators we have tested over the last 20 years, it is the first one we have tried that beats the "buy and hold" approach. Most technical indicators do not claim to outperform "buy and hold" - they simply limit the losses. Because we did not offer this indicator at the beginning of the back test period, our clients investment results were quite different from what we show in the back test.
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