Exploit U.S. Stock Market Dips with Margin?

A subscriber requested evaluation of a strategy that seeks to exploit U.S stock market reversion after dips by temporarily applying margin. Specifically, the strategy:

• At all times holds the U.S. stock market.
• When the stock market closes down more than 7% from its high over the past year, augments stock market holdings by applying 50% margin.
• Closes each margin position after two months.

To investigate, we assume:

• The S&P 500 Index represents the U.S. stock market for calculating drawdown over the past year (252 trading days).
• SPDR S&P 500 (SPY) represents the market from a portfolio perspective.
• We start a margin augmentation at the same daily close as the drawdown signal by slightly anticipating the drawdown at the close.
• 50% margin is set at the opening of each augmentation and there is no rebalancing to maintain 50% margin during the two months (42 trading days) it is open.
• If S&P 500 Index drawdown over the past year is still greater than 7% after ending a margin augmentation, we start a new margin augmentation at the next close.
• Baseline margin interest is U.S. Treasury bill (T-bill) yield plus 1%, debited daily.
• Baseline one-way trading frictions for starting and ending margin augmentations are 0.1% of margin account value.
• There are no tax implications of trading.

We use buying and holding SPY without margin augmentation as a benchmark. Using daily levels of the S&P 500 Index, daily dividend-adjusted SPY prices and daily T-bill yields from the end of January 1993 (limited by SPY) through November 2022, we find that: (more…)