VTI ETF, Our Aggressive Growth Portfolio, And Our Market Outlook

Thesis and Background

Now is a challenging time for investors. Stock valuation is at a record high, bond yields are at a record low, a war is undergoing, and several crucial macroeconomic uncertainties are unfolding. As mentioned in our newly launched market service, we feel urged to remind investors that at times like this, it is especially important to stay disciplined and stay with simple and proven methods that you truly understand.

And a key to staying disciplined is to ALWAYS delineate short-term survival/withdrawal from long-term growth. Sadly, we’ve seen too many people around us make the tragic wrong moves, especially at our current extreme market junctures. And the Vanguard Total Stock Market ETF (VTI) is a cornerstone fund in both our survival and growth portfolios. For the survival portfolios, we ourselves have been seeing and publishing warning signs since last November to urge readers to conserve cash and hunker down. For example:

• In our Nov 22, 2021 article, we cautioned readers that our model showed a record low exposure index (“EI”), a key signal our proprietary algorithm monitors – a key parameter we use to allocate our cash reserve in all our accounts. We mentioned that now was a good time to increase cash reserve and be in a hunker-down mode with the summation SPY yield and treasury rate at a historical low.
• In our Dec 16, 2021 article, we cautioned again it was a good time to move toward maximum cash reserve and be in a hunker-down mode because of the warning signal from our exposure index again.

Those were clear signals for us. And we sold some equity and bond to increase our cash allocation. Shortly after this allocation change, both the stock and bond market went through a sizable correction as you can see next. As of this writing, VTI fell by about 7.5% (and the NASDAQ index fell more if you hold those funds). At the same time, the 10-year Treasury bond fell by more than 4%.

In this article, we switch the focus to the aggressive growth portfolio (“AGP”). Looking forward, we see now is a good time to deploy some of the cash we reserved (and hopefully you did too) when both the equity and bond market peaked. More specifically, the remainder of this article will show you how we use VTI ourselves guided by a few simple and timeless concepts to seek aggressive growth. Specifically,

• Opportunistic equity-bond rebalance. We use an equity-bond index to A) monitor the adjusted yield spread between equity and bonds, and B) opportunistically allocate equity such as VTI. Currently, the spread is toward the thinner end of the historical spectrum, and that is why are maintaining an equity-to-bond ratio of 70%.
• Dynamic leverage. We use an algorithm to systematically adjust leverage based on volatility and market valuation to generate reliable long-term aggressive growth. We are also maintaining a low level of leverage now because of the elevated volatility. As you can see, our leverage ratio (TQQQ target weight) is currently 6.9%. To put it under perspective, our ceiling for the leverage ratio is 25%.
• Tactical holdings. We also hold a few tactical holdings to generate extra alpha. As you will see later, now we see value stocks such as Tyson Food (TSN) and gold-silver trade as favorable opportunities in addition to VTI.

VTI and our Aggressive Growth portfolio (“AGP”)

Most of the detailed information about the fund itself has been covered in my earlier article and won’t be the focus today. Here we will just briefly recap the most relevant information before we move onto the main topic. The VTI fund holds 3700+ holdings, encompassing large-, mid-, and small-cap equity across growth and value. The main difference between VTI and the S&P 500 index is that the S&P 500 is all large-cap. But the VTI fund offers exposure to mid-cap, small-cap, and microcap – the reason we like this fund.

Under this background, the following two charts show our detailed holdings in the AGP, its performance in Feb 2022 (since we launched our marketplace service), and its performance since May 2021 (when we first wrote about it on Seeking Alpha). A few observations:

• The timeframe shown in these charts is really short compared to our investment horizon and there is no need to read too much into the specific numbers. At their current level (plus and minus a few %), they can all change within a day of random market fluctuation. Backtests results over long periods are provided later.
• However, the data does provide a peek into the fundamental features of the AGP. As can be seen, thanks to the proper diversification and disciplined leverage, A) the leveraged portfolio has been leading the overall market the majority of the time, and B) the leveraged portfolio actually fluctuates LESS than the overall market despite the leverage (especially during a highly volatile market correction like we experienced during the last week).
• Finally, you can see that we like a simple and concentrated portfolio. Both our own accounts and the accounts we help to manage repeatedly show that sticking to FEWER but well-understood holdings actually LOWERS risks. Our experiences repeatedly show that a few tickers (as few as 7 core holdings in the AGP) can capture 80% of the alpha there is already. It is kind of like playing LEGO. One way to play is to gather as many LEGO pieces as you can (there is nothing wrong with it and we used to do the same ourselves). A different approach is to understand a few pieces so well that you can use them to build anything and be confident that whatever you build will endure. And this is the approach we like now – simpler portfolios, less work, but more alpha.

How we use VTI to seek aggressive growth?

Many of your reading this probably know about Ray Dalio’s All-Weather Portfolio (“AWP”). It is an approach to provide portfolio-level diversification using four different asset classes (stocks, bonds, commodities, and gold) in the following ratios.

• 30% US stocks
• 40% long-term treasuries
• 15% intermediate-term treasuries
• 7.5% commodities, diversified
• 7.5% gold

The central idea of AWP is rebalancing and risk parity. It consists of assets that go in different directions in different macroeconomic conditions, and it forces you to reduce the expensive assets and add the cheaper ones. It has been shown to be very effective in limiting volatility and drawdowns. The name itself suggests the essence (or the goal) – it is a portfolio built to weather any storm.

In practice, there are however several issues in the implementation of the idea. First, it is difficult, at least for individual investors, to invest in commodities with reasonable costs/fees. Second, it might be too conservative for many investors (with only 30% stocks). Third, the fixed allocation does not make intuitive sense. As a recent example, during the 2020 March COVID-19 crash, treasury yields dropped to a level (0.6% for 10-year maturity) that Dalio himself considered silly to own government bonds. Yet if you stick to the original AWP, you would still be holding 55% of government bonds in your portfolio.

We truly believe in the underlying AWP idea, and it has been the backbone of our own investing journey for more than a decade. Recognizing the above issues, we have been researching ways to revise it to a version that is more applicable to us. And the methods we described here are the culmination of our own research, proven and vetted by our own experiences since about 2012. The key strategies are:

1. We do not hold commodities.

2. We use 30% as the floor for stock allocation and add to it based on the yield spread between the overall stock market and 10-year treasury yield.

The following chart shows the yield spread between the overall market (represented by VTI) and the 10-year treasury rate. As can be seen, the spread is indeed bounded and tractable. The spread has been in the range between about 0.5% and -1.25% the majority of the time. Suggesting that when the spread is near or above 0.5%, the stock market is relatively undervalued, and we would sell almost all treasury bonds and buy stocks. And vice versa.

Although note that the yield spread that we actually use is a bit more complicated than this (but the data in the chart illustrates the essence of the idea). In practice, the dividend yield from the stock market does not always reflect business fundamentals and can be distorted by things like:

• tax law – dividend can change quite a bit depending on whether the tax codes favor it or not.
• political climate – dividend can also change based on how politically popular it is.
• composition of the market index – dividend yield of “the market” can also be biased if the index is dominated by a few mega-caps who do not pay dividends – like what we are experiencing now.

So in our model, we have a proprietary algorithm to adjust for these factors, correct the distortion, and use the adjusted spread to determine our bond-stock allocation.

Currently, the spread is toward the thinner end of the historical spectrum, and that is why are maintaining an equity-to-bond ratio of 70%.

3. We use leverage dynamically to achieve aggressive growth. Details of this concept are explained in this Youtube video tutorial in case you are interested.

We use the VIX index to measure the volatility of the market and adjust our leverage. We leverage less when VIX increases and more when the VIX decreases according to the blue curve. In practice, we also cap my maximum leverage at 25% as shown by the green line. More specifically, the blueline follows a 1.5th power-law relationship in the form of Leverage ~ 16/VIX^1.5. So that when VIX = 16, the leverage is 25%, i.e., the maximum is reached and 25% of our equity exposure will be leveraged. In case you are wondering where we got these magical numbers, the rationale is twofold:

• VIX=16 is about the historical average of the market volatility index and we are comfortable cranking up to our maximum leverage level in the AGP when VIX is near or below the historical average.
• The 1.5th power-law gives us the level of sensitivity that we are comfortable with.

How did our method perform?

We have been applying the above approach on our own and others’ accounts (family members and close friends). The following chart shows the backtest result of our aggressive growth portfolio from 2006 to 2020. We have been actually implementing the strategy ourselves since ~2012 and our actual return is even better because of the success we’ve had with our tactical holdings.

And the second chart compares the risks in terms of maximum drawdowns in three market events – the 2008 financial crisis, the 2020 COVID crash, and the more recent market jitter during September 2021. As seen, the leveraged AGP actually provided significantly lower risks, not only measured by drawdowns, but also by other metrics such as standard deviation, worst year loss, Sharpe Ratio, Sortino Ratio, et al. During the 2020 COVID crash, it “only” suffered a maximum drawdown of -7.3% (thanks to the hard landing of treasury bond yields and above all the disciplined approach), compared to about -20% form the S&P 500.

Conclusions and final thoughts

VTI offers one of the best choices for investors looking for broad market exposure, with low cost, and high liquidity. This article describes a method of using VTI to build a portfolio seeking aggressive growth. The specific strategies are:

• Opportunistic equity-bond rebalance based on spread yield based on the yield spread between VTI and the treasury bond rates.
• Dynamic and disciplined leverage based on volatility and stock market valuation.
• Tactical holdings across other asset classes to further boost generate extra alpha.

And looking forward:

• Currently, the spread between VTI yield and treasury rates is toward the thinner end of the historical spectrum, and that is why are maintaining an equity-to-bond ratio of 70%.
• In terms of leverage, we are also maintaining a low level of leverage now because of the elevated volatility. Such large volatilities are unlikely to subside in the near term due to several key uncertainties: the Russian geopolitical situation, Fed rate decision, inflation data. And at times like this, we feel urged to remind ourselves and our readers to stay disciplined and stick to methods that we truly understand.
• In terms of tactical holdings, we see value stocks such as Tyson Food (TSN) and gold-silver trade as favorable opportunities in addition to VTI. You can see our thinking about the rotation to value stocks in more detail in this article. And for the silver-gold trade, the current gold-silver price ratio is near the historical peak and offers a good setup for a silver-gold trade play. That is why we are also holding SIVR as a tactical holding.
• Lastly and most importantly, you should NOT pursue growth at all unless/until you have put aside enough funds to ensure your survival in the near term (that is why we maintain two separate portfolios ALL THE TIME ourselves).