The Best Macro Indicator, Round Two

Another Effective Strategy with High-Yield Spreads

Happy New Year, everyone! I hope your 2025 is off to a fantastic start—may it be filled with green candles and minimal drawdowns! 📈

A New Community Discovery

I recently joined a trading community led by TearRepresentative56, and it’s been a breath of fresh air. They share a ton of educational materials and actionable tips, with an emphasis on data-driven but primarily discretionary swing trades. The best part? The community vibe is actually supportive and useful, which is pretty rare these days. You do have to sign up, but if you’re as curious about short-term, data-driven strategies (like parsing option flows) as I am, I’d say it’s well worth the minor hassle.

But here’s a twist: the host recently shared a longer-term, rule-based strategy that nicely complements those short-term trades. Even better—it uses the same “best macro indicator” that I introduced a while back: high-yield credit spreads. Naturally, I had to see if this approach would fly in QuantMage.

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📣 Disclaimer: This content is purely for informational purposes and not financial advice. Please do your own research and consult a financial professional before making any investment decisions.

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Original Rules: Risk-On, Risk-Off

The author’s method flips risk on or off based on high-yield credit spreads. In their example, they use SSO (a 2x levered S&P 500 ETF) when it’s risk-on. But the precise triggers—“35% drop from a recent high” or “40% rise from a recent low”—weren’t exactly straightforward to replicate in QuantMage, partly because the notion of “recent” isn’t clearly defined:

https://tradingedge.club/posts/tears-trading-school-tears-leveraged-etf-strategy-delivers-24x-returns-vs-the-sps-3x

My Adaptation for QuantMage

After some fiddling around, here’s what I did:

1. Entry: Look at the spread’s 200-day maximum drawdown. If it’s more than 30%, that triggers a risk-on move.

2. Exit 1/2: If the spread’s 85-day return is above 15%, that signals risk-off.

3. Exit 2/2: Instead of an exponential moving average, I used a 330-day simple moving average for the crossover check.

These adjustments roughly match the original backtest returns, which reported a 16.3x gain over a 17-year period—about an 18% annualized return (CAGR).

Squeezing Out More Juice

An 22.6% CAGR is already solid, especially with a Sharpe ratio over 1 for such a straightforward strategy. But, like any self-respecting systematic investor, I wanted to push it further. Here’s what I did:

• Switched Risk-On Asset: I tried using QLD (a 2x Nasdaq-100 ETF) to supercharge returns.

• Added Another Canary: To control drawdowns and volatility, I tested a bunch of different “canaries” that tell me when to toggle between a levered ETF and a more standard ETF. Ultimately, I landed on an emerging market canary using EEM.

I could have used QQQ instead of XLK here as a tech sector ETF, but the latter gave me a tiny bit better result in simulation. This tweak bumped the CAGR from 22.6% up to 27.1%, while actually reducing the maximum drawdown from 30.2% to 27.2%. Gotta love when you get both more return and less risk!

Going One Step Further

Finally, I introduced UUP (a dollar index ETF) as the risk-off asset instead of simply being out of the market. The result? An impressive 29.8% CAGR over about 17 years, with a max drawdown of 26.8%:

And check this out: the strategy didn’t have a single negative year in the entire sample period! That’s impressive.

If you’re curious about all the gory details, you can play around with this setup yourself here.

Bottom Line

So what’s your take on using high-yield spreads as a “canary”? Personally, I’m more convinced than ever—these spreads seem to be pretty darn good at waving the yellow (or green) flag for equity risk. But I’m open to the idea that this could all be a fluke. More importantly, are there even better canaries out there that you’ve come across? Can you refine or replace high-yield spreads with something more predictive?

Drop your thoughts in the comments!

Here's to a successful and prosperous year ahead. May the markets be ever in your favor! 🚀