Macro Regime Classification

FM103 classifies each rebalance period into a macro regime using three signals: the CBOE Volatility Index (VIX), the 10Y–2Y Treasury yield spread, and the S&P 500 trend (200-day moving-average position). The classification powers the Regime-Conditional sub-pill and feeds the regime-breadth term in the Strategy Health Card. This article explains why these three signals, how the buckets are defined, and what the literature says about regime detection in macro time series.

Why these three signals

A regime classifier in a backtest diagnostic has three constraints:

1. Available historically. Daily data going back at least 20 years.
2. Free or low-cost. Must be accessible without subscription.
3. Distinct economic meaning. Each signal should capture an independent risk dimension.

VIX (volatility), term-spread (recession risk), and S&P 200-day position (trend) satisfy all three and together cover the three risk dimensions most factor strategies care about.

Signal 1: Volatility regime (VIX)

The VIX (CBOE's implied-volatility index from S&P 500 options) is the canonical fear gauge. The threshold:

• VIX > 22: high-vol regime
• VIX ≤ 22: low-vol regime

The 22 cutoff is the practitioner standard: the long-term VIX median is ~17, the historical mean is ~20, and 22 captures the upper-third of vol days. Strategies that work in low-vol environments often fail in high-vol; the regime label flags this.

Signal 2: Yield-curve regime (10Y−2Y)

The 10-year minus 2-year Treasury yield spread is the most-cited recession indicator (Estrella & Hardouvelis 1991). An inverted curve (negative spread) has preceded every US recession in the modern era. The threshold:

• Spread > 0: normal regime
• Spread < 0: inverted regime

Inversion typically lasts months to a year before the recession arrives; the regime label catches the inversion window itself, not the recession.

Signal 3: Trend regime (S&P 200-day MA)

The price-vs-MA200 indicator is the simplest possible trend definition. The threshold:

• S&P close > MA200: bull regime
• S&P close < MA200: bear regime

The 200-day window is conventional (Faber 2007). Variations (50/200 cross, 100-day MA) produce similar regime labels with different transition timing; the 200-day is robust to recent noise.

Composite labels

Three binary signals combine into 8 cells, but only 4–5 are observed in practice (high-vol bull markets are rare; low-vol inversions occur but briefly). The composite labels FM103 uses:

• low-vol bull: the baseline expansion regime, dominant in 2013–2019 and 2024–2025
• high-vol bear: the textbook crisis regime, dominant in 2008–2009 and Q1 2020
• inverted curve: the late-cycle regime, dominant in 2019 and 2022–2023
• high-vol bull: recovery regime, dominant in mid-2020
• low-vol bear: distribution regime, rare

The classifier assigns each rebalance period to the most-occupied label across the days within the period (modal regime per period).

What the academic literature contributes

Hidden Markov Models (Hamilton 1989) and Markov-Switching models (Ang & Bekaert 2002) provide statistically rigorous regime detection. FM103 uses a simpler signal-threshold approach because:

• Backtests rarely have enough periods to estimate HMM transition matrices reliably.
• Transparent threshold rules are easier to communicate and reproduce.
• HMM-based regimes are not always interpretable; threshold rules attach directly to observable macro signals.

For users interested in formal regime detection, SC001STCB includes an HMM module (see Stochastic Methods) that can be applied to a single asset's return series.

Caveats

• US-centric. VIX, 10Y−2Y, and S&P trend are all US signals. Non-US factor strategies see imperfect regime labels.
• Threshold-stable but transition-noisy. A VIX of 21.9 is "low-vol" and 22.1 is "high-vol" despite no economic difference. The labels drift across the boundary in regimes that hover near a threshold.
• Three signals don't capture everything. Credit spreads, dollar index, oil all affect equity factors; the classifier ignores them in favor of parsimony.