Portfolio Rebalance / April 03
Following the Signal Sigma Process
The approach to this article follows the step by step process described here. All visuals are sourced from various instruments available in the platform. If you are using the Portfolio Tracker, you’ll be able to see how we set it up for our own portfolio at the end of this article.
Note: The Sigma Portfolio Tracker has a new home in the pre-release version of our new app! You can access it here.
In the asset management industry, there are times when decision making is nuanced, complicated or otherwise not straightforward. Other times, it’s the opposite, and decision making is easy and rather mechanical, following exact rules and guidelines.
So far this year, we have been placed in a rather awkward situation. While our main asset allocation model (Enterprise) became rather defensive, we were more bullishly biased thanks to our fundamental projection for the equity market.
Fun fact - in V2, we can now use the time machine date selector and explore the different positioning of any strategy or portfolio at a certain date in the past. We’ve set the date to February 25 and looked at the portfolio of Enterprise to gauge the amount of risk-taking within the model. We would describe it as clearly “defensive”, with only 28% allocation to stocks.
So far, so good. However, the nuance comes into play when trying to appreciate if a correction is just a technical and temporary supply and demand problem, or “something more sinister”. We have previously presented variations of the chart below to guide our actions. This snapshot was taken on March 12, when a temporary low was reached, and our assumption was that we’d see a sizable rebound that either results in a consolidation (B) or fails at the 200-DMA and turns lower (C).
We were right about the rebound. The temporary low occured on the very next day, March 13. However, our base case assumption was that all of the tariff drama would resolve in a consolidation pattern (B) and not in an outright breakdown.
Institutional flow data seemed to confirm our assumptions, as Gamma Exposure was turning higher for a variety of impactful ETFs and stocks. Dark pools flows at yesterday’s close were indicating buying activity under the surface.
Even a more “naive” but still powerful analysis method - combining the Daily MACD trend to the Weekly MACD trend for major sector ETFs was indicating that a bottom was close to being put in place and a reversal might be close by.
In other words, dip buying at that juncture was not only entirely defensible, but something that large institutional players actually did. There’s no point in analysing the past too much right now, since any decent indicator would have signalled more bulishness than bearishness.
Today’s price action has nothing to do with the market’s technicals or past fundamentals, and could not have been “predicted” by any statistical model (except Enterprise apparently). It is of course the result of a calculated decision by the Trump administration.
In recognition of heightened risk, our move in the Sigma Portfolio was to raise cash levels at 11% and lower risk, by cutting tech-related exposure (QCOM, META, NVDA, FTNT, APP) - as seen below:
In hindsight, it was a great move, but one that could have easily gone down either way. Trump’s tariff announcement could have been “better than feared” and provoked a reflexive rally - which was actually our base case assumption and the reason we did not reduce exposure more.
So where does that leave us? Well, at this point, the market is starting to price in a recession, and a compressing of valuation multiples is underway. According to the latest from Goldman’s investment desk, median earnings of $253 / share could be multiplied by 20x (in a comparatively “fine” scenario) and it would still result in a sizable downside.
Fundamentally speaking, we see the same potential downside to $505 on our adjusted chart (S2, and the bottom of the trading range).
On a strict technical chart (such as Enterprise uses for decision-making), the exposure cutoff point is represented by the lower trendline, at $544. Given current prices, Enterprise will issue a general stop-loss for the equities asset class after today’s close is recorded, to come into effect tomorrow. As long as SPY trades below $544, Enterprise will not re-allocate to equities.
This makes our job of managing a portfolio easier, not harder. We never assume that we know more than the market does and generally let the price action guide our own actions. And the message we’re getting right now is loud and clear — we need to keep de-risking and selling rallies. While Enterprise might fully sell out of SPY tomorrow, it may re-instate that position on Tuesday (April 08). We don’t want to swing allocation by 40% in a single day in our live portfolio so we’ll do it bit by bit in the next couple of days.
To gauge which positions need reduced, we’ll use our latest Linking feature to sync the Sigma Portfolio to a Watchlist (screening template here). The primary metric that shows a position is “lagging” is Z-Scroe Relative. Combined with the Dark Pools 1M metric, and the Total GEX to Volume, LLY stands out as the “worst offender”, with NVDA a close second.
Since we have already cut exposure in tech stocks this week, we’ll issue a sell order for LLY at tomorrow’s market close (Friday 04).
Overall, our equities exposure will go down from 66% to 62%.
On another note, despite the perceived inflationary effect of tariffs, bonds are reacting more strongly to recession fears than inflation angst. At current prices, TLT will have achieved a technical breakout, above $92. It will certainly merit more inclusion in our portfolio than the 16% position we already own.
A different and personal take on this market…
One which by no means is a way to manage a portfolio - yet has a certain degree of value.
I was struck by Treasury Secretary Bessent’s comment that the recent market decline is a “Mag 7 problem, not a MAGA problem”. On the surface, he appears to be pointing to a correction caused by inflated valuations in a certain sector of the market. The subtext I personally got was different:
“The stock market is a problem for a few rich individuals, who can afford to invest in Tesla and Nvidia, and not so much an issue for the common man.”
Indeed, more than 70% of stock market wealth is owned by around 5% of the population. The rest? They don’t directly suffer (as in they don’t see their portfolio declining in value and stress over portfolio positioning like we do). But what does everyone care about? Including every MAGA voter? Interest rates, of course.
I do believe this administration is bent on lowering them, potentially to 2020 levels. That would imply a 50% upside for TLT, which moves inversely to long term rates.
Already the tariff announcement is pushing interest rate traders to price in 4 cuts for 2025.
In a sense, what was uncertain yesterday has now become a certainty. From here on out, problems can be solved just as easily as they were created - by the stroke of a pen. The question is - who is going to fold first in this game of global trade “chicken”?
The U.S.? China? or the EU?
Trump’s betting that it’s not going to be the U.S. It’s costing him approval points with wealthy voters and he is aware of it. But the “pain point” is a ways away below the last price and frankly, we’d rather not find out where it is using our own money.
Andrei Sota