Bond UI1 (Paul Novell’s unemployment bond strategy)

Bond UI1 is a tactical bond strategy from Paul Novell of the Investing For A Living blog, described in July 2019. It uses one economic signal, the US unemployment rate against its 12-month average. While unemployment is at or below that average it holds credit bonds; when it rises above, it holds US Treasuries.

The idea#

Credit bonds, such as high yield, corporate, and emerging market bonds, pay more than Treasuries because they can default. Most of that risk shows up in recessions, when credit bonds fall and Treasuries usually rally.

Novell used his unemployment indicator, which he first built to time the stock market, to decide which side to be on. Unemployment rising above its recent average is an early recession warning, so the strategy moves from credit to government bonds before the worst of a credit sell-off.

How it works#

At the close of the last trading day of each month:

1. Compare the latest US unemployment rate (FRED series UNRATE) with the average of its last 12 monthly readings.
2. If it is at or below the average, hold US high yield (HYG), emerging market (EMB), international (BNDX), and US corporate bonds (LQD) at 25% each.
3. If it is above the average, hold short (SHY), intermediate (IEF), and long Treasuries (TLT) at a third each.

The unemployment rate counts from its release date, as first reported.

What the backtest shows#

The test starts in mid-2013, when the international bond fund begins. Since then Bond UI1 returned about 1.3% a year, a little below the US bond market (AGG, 1.7%) and far below a 60/40 stock and bond mix (9%). Its worst drawdown, 26%, ran from March 2020 to October 2022 and has not been recovered, deeper than the bond market's 18%.

It had a strong 2019, gaining 15% against 8%. Since publication in mid-2019, though, it has lost about 1.6% a year. In 2020 unemployment rose only after the March credit crash, so it held credit bonds through the fall and moved to Treasuries as credit recovered. In 2022 it lost 15% against 13%: unemployment was falling, so it held credit bonds, which fell with rising rates too.

When it struggles#

• Rate-driven bond bear markets. Both of its baskets are bonds, so when rates rise fast there is nowhere to hide. The 2022 bond crash is its worst loss.
• Sudden credit shocks. Unemployment is reported with a lag, so a fast sell-off like March 2020 is over before the signal moves.
• Long Treasuries on the way out. When it does switch, long Treasuries can fall sharply if inflation, not recession, is the problem.

Using it on Tactfolio#

The live strategy above runs Novell's two baskets with FRED's unemployment rate. Copy it to change the baskets or add a price-trend check, or compare it with Novell's price-based tactical bond strategy and the stock version of the same signal, Growth-Trend Timing.

Year by year

* Partial year.

The rules as implemented

This is the exact tree Tactfolio runs, rebalanced monthly with signals and trades at the close. Open it to inspect or copy it.

Sources and caveats

• Paul Novell, Enhancing Returns of TAA Bond Strategies (2019)

• Risk-on holds HYG, EMB, BNDX, and LQD at 25% each; risk-off holds SHY, IEF, and TLT at a third each, as in the source.
• The signal is the author's monthly SPY-UI indicator, the unemployment rate (FRED UNRATE) against the average of its last 12 monthly readings; its full definition is now on a members-only page of the author's site.
• BNDX begins in mid-2013, so the ETF-era test starts then.
• Each economic figure counts only from the day it was first published, and as first reported: at a month end the latest figure is the previous month's, the one-month lag the source describes.
• Signals and trades use the close of the last trading day of each month, as in the source.

Common questions#

What is Bond UI1?#

It is Paul Novell's tactical bond strategy that holds credit bonds while US unemployment is at or below its 12-month average, and Treasuries when it rises above.

What ETFs does Bond UI1 use?#

HYG, EMB, BNDX, and LQD at 25% each when unemployment is stable or falling, and SHY, IEF, and TLT at a third each when it is rising.

Why use the unemployment rate for bonds?#

Credit bonds lose most in recessions, and rising unemployment is an early recession signal, so it tells the strategy when to prefer the safety of Treasuries.

Does Bond UI1 still work?#

Since mid-2019 it has lost about 1.6% a year, mostly in the 2022 bond crash. The live record on Tactfolio shows how it is doing now.

Related strategies

• Growth-Trend Timing (Philosophical Economics’ GTT)
• Growth-Trend Timing with unemployment (GTT-UE)
• Growth-Trend Timing with job growth
• Growth-Trend Timing with housing starts and income