Portfolio Rebalance / August 28
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.
As the August “Yen Carry Trade Crash” has led to a V-shaped recovery, investors have been lulled into a period of low volatility, low volume trading pattern in anticipation of the next major catalyst. This may be NVDA’s earnings call later tonight, expected to produce a + / - 10% move in the stock and subsequently affect many other major names in the semiconductor and technology space.
Friday’s Core PCE data release may as well prove pivotal in the sense that the future path of Fed policy lies in the balance. Ultimately, investors are looking for a good reason to either chase the rally in equities from current prices or an excuse to take quick profits (and sell stocks).
What we do know for sure is that Dollar Transaction Volume does not confirm the rise in prices. While it’s true that “for every seller there is a buyer”, the question is always “at what price”? And the current answer from a volume perspective is “not at current prices”. In other words, when volume does come back up and above the recent average, it’s likely to be at lower prices, not higher.
Asset Class Allocation
The first step in determining optimal portfolio positioning is taking a look at the performance of the main asset classes, and determining which are suitable for investment. The Asset Class Overview Instrument gives us a clear macro picture.
All major asset classes remain investible this week, except Commodities.
The exchange trading volume interpretation for SPY is backed up by our own technical chart as well as the volume based analysis that can be accessed at Tradingview.com.
Resistance at $567 could be surpassed on another blowout earnings call from NVDA, for example. Absent this catalyst, buying interest can be found at around $540 and more serious bids go down to $505. We still have no confirmation of support on the V-shaped recovery rally, as a downside move has not yet “re-tested” any meaningful price point on adequate volume.
Our levels analysis closely aligns with the volume study from Tradingview.com.
Commodities (DBC) bounced convincingly during the past week and only managed to clear the M-Trend level for one day (on that day, Enterprise happened to trade, by the way). At the time of this writing, commodities remain un-investible according to our process by a very thin margin. Rejection or breakout? Only time will tell, and we’ll need to wait until next week to find out.
Gold’s (GLD) has traded favorably in the past week, continuing the grind higher without any major hiccups. The interesting part about bullion is how well it has become correlated with various other speculative assets (during the last 200 days, investing in SPY or GLD would have yielded the same returns for example).
Despite the good short-term support, Gold is well overbought longer term and now reaching the top of its trading channel. Some are speculating that large institutions (Central Banks) are driving the rally via physical delivery contracts, while the retail crowd is selling via ETFs.
GLD vs SPY, last 200 trading days -- very different types of assets, almost identical results since Nov'23
TLT has lost some momentum in the past week, as short term overbought conditions and some waning recessionary fears are keeping advances limited for the moment. We don’t expect any major movement on TLT until Friday, when Core PCE data is released.
Enterprise, our core investment strategy, has maintained a similar approach to stocks as last week, but has preferred exposure to commodities in the detriment of bonds for a couple of days at least.
Stocks exposure via SPY rises from 73% last week to 76% today.
Bonds exposure (IEF) is massively reduced from 22.8% last week to 8.86% today. The reasoning behind the move was the overbought condition of bonds, versus the much more appealing risk-reward proposition in commodities.
The position in GLD is maintained near 2.7%.
Commodities were investible by Monday’s close, when Enterprise decides on asset class allocations for the week. DBC was set at around 12% portfolio weight and bought on Tuesday. However, this version of the model, which uses intra-week stop loss triggers, has detected a violation in DBC and is closing the position today.
Due to the sale of DBC, cash rises to 13.5% of portfolio weight.
Since this model only trades 4 ETFs, we use it to judge overall portfolio positioning. The 76% stocks exposure in Enterprise is quite risk-on, but this exposure is balanced by the 13% cash holding. We’ll need to wait until next week to better assess which is the best complementary asset class for equities in the portfolio.
2. Sector / Industry Selection
The next step in creating our portfolio positioning is to break down each broad asset class into more granular groups of assets. This will help us understand which pocket of the market is outperforming or underperforming and make our selection accordingly.
Since Equities are an investible asset class, we’ll take a look at how different Factors are performing and check for any notable opportunities.
We have included tables for this week and the prior 3 article editions in order to help you compare developments (click on the arrows or thumbnails to cycle through the tables).
As the market has recovered as abruptly as it fell, most factor ETFs have gone the same route. All instruments are trading above all key averages. Presently 6 / 10 factors are experiencing a positive medium-term trend, while SPY itself is still negative. This is encouraging from a market breadth perspective. Furthermore, 7 factors are now outperforming SPY on a Relative Z-Score measurement, which is also a great sign for broad participation (for context, during a large part of 2023 and 2024, only 2-3 factors outperformed).
While several factors are overbought in the short term, the outperformance has been uneven. Check out the following chart below, which highlights 200-day performance, very useful from a momentum perspective:
Value Stocks (IVE), Equally Weighted S&P500 (RSP), the Dow Jones Industrial Average (DIA) and Foreign Developed Markets (EFA - not charted) are the only ETFs to establish new recent highs. In contrast, a factor like QQQ, which many have bought on the dip, has failed to establish a new ATH (despite still outperforming RSP or IVE).
Nevertheless, the rotation that started in late July is alive and well. We’d be wise to take note.
Among more granular Factor Returns, companies with a high debt load have been popular with investors, most likely on account of lower expected interest rates (lower rates should act as a tailwind to heavily indebted companies).
Earnings Yield remains a top factor at the longer timeframes, but has fallen off recently. At the 1 week interval we are getting a strong improvement, so a buying opportunity may present itself.
Here’s how we stand from a Sectors standpoint:
We have included 3 former tables from previous articles, for your convenience.
The Sectors dashboard presents a more mixed picture than the factors leaderboard. 5 / 12 sectors are experiencing a negative medium-term trend, including the highly influential Tech (XLK) and Communications (XLC) ETFs.
The only overbought sectors, both on a short and long term basis are those usually associated with “risk off” expectations. Namely defensives like Healthcare (XLV), Staples (XLP), Real Estate (XLRE) and Utilities (XLU). This is a set-up which raises serious questions about the validity of a true risk-on rally, which should normally lift the high beta sectors (XLK, XLY, XTN). However, these risky ETFs are all relative to SPY underperformers at the moment, in a warning sign for any investor attempting to chase this rally.
While there are no true tactical allocation opportunities present, the leadership and momentum exhibited by defensive sectors is uncommon. Furthermore, Tech (XLK) looks like being rejected at a key resistance level:
As Nostromo has come alive this summer, it pays to explore the logic of this quirky tactical model.
The portfolio is pretty straightforward. On the equities side, Nostromo has picked up Basic Materials (XLB) and the Equally Weighted S&P500 (RSP) on the dip. These two ETFs make up the whole 81% stocks exposure. It plans to close both positions on the appropriate signals, whenever they occur.
In their stead, a position in SPY is targeted -- but since SPY is overbought and on a positive MACD crossover, there is no way any signal can trigger for now (oversold conditions or a negative crossover are pre-requisites).
The position in TLT, at 41% is slated for an increase on a BUY signal. Similar to SPY, there’s no way such a signal can trigger at the moment.
If leverage is excluded, this model mirrors Enterprise in that it’s Stocks - Bonds allocation stands at 66% - 34%.
However, Nostromo is using leverage to invest, as its negative (-22%) cash allocation shows.
3. Individual Stock Selection
Millennium Alpha has refreshed portfolio holdings this week, and a host of new positions have entered the portfolio.
Additions:
Frontdoor Inc - FTDR
IES Holdings Inc - IESC
Diamondback Energy Inc - FANG
Motorola Solutions Inc - MSI
Trane Technologies plc - TT
Coca-Cola Consolidated Inc. - COKE
United Therapeutics Corporation - UTHR
Arista Networks - ANET
MercadoLibre Inc. - MELI
Removals:
Tenet Healthcare Corporation - THC
Fair Isaac Corporation - FICO
Blackstone Group Inc - BX
Allison Transmission Holdings Inc - ALSN
United Rentals Inc - URI
Godaddy Inc - GDDY
Lennox International Inc - LII
Western Midstream Partners LP - WES
Carlisle Companies Incorporated - CSL
Note that the portfolio exposure is very balanced -- no factor or sector holds an extreme importance. RSP, IVE and DIA, factors that we’ve previously identified as outperforming hold a significant place on the sector correlation side.
There are some primarily tech stocks present (NVDA, MELI, ANET), but all of the other holdings are non-tech. On August 26, Millennium Alpha has recorded a fresh all-time-high, as stocks recovered from the correction.
4. Market Environment
The next step in our process is to take into account the type of market environment that we are currently trading in. For these purposes we use the Market Internals and the Market Fundamentals Instruments. Comments on the overall state of the market can usually be found in our Weekly Preview Article.
Market breadth has recovered nicely from the August lows, but the number of stocks above their 20-DMA’s looks extended. Whenever 850 stocks (or more) were trading above this average, the market has recorded at least a minor pullback. Longer term, the recovery at the 200-DMA level is encouraging and healthy. This indicator is a bit of a mixed bag currently, so the rating goes to “neutral”.
Neutral Signal in Stocks trading above their 200-day Moving Averages
As a contrarian indicator, sentiment works best near extremes. The current reading (67/100) is in “Greed” territory, but take a look at the second panel. This is how the indicator would look like if only the 2024 year-to-date readings were considered.
Sentiment is clearly in “Extreme Greed” territory, as far as 2024 is concerned.
Slightly Bearish Signal in Sentiment
The comparison of Z-Scores reveals the disparity between large cap performance (SPY) and the top 1000 stocks by dollar volume (the broad market), equally weighted.
The trend is clearly showing a normalization of large cap and small cap performance (favoring the small caps). We would be inclined to interpret this as bullish, since it shows the market is resilient, despite momentum pressures in the large cap space.
Bullish Signal in Market Internals Z-Score
We’ve extensively covered transaction volume in our Daily Briefings as of late and we’ve also previewed the indicator at the start of this article. It’s bad. Really bad. Volume needs to turn up, ASAP.
(VERY) Bearish Signal in Dollar Transaction Volume
5. Trading in the Sigma Portfolio (Live)
After reviewing all of the above factors, it’s time to decide on the actual investing strategy for our real-life portfolio.
The conclusion to all of our observations this week translates into more of a wait and see approach. We don’t need to risk more than we are already risking. In the near term, there are some clear technical headwinds that need to get resolved. The most likely scenario remains that we will get a correction in stocks (and maybe bonds as well) that establishes a better support level.
Long term prospects are looking good. We’ve already started work on our Q3 Market Outlook, and if the economy is able to avoid a recession, we’re probably looking at double digit returns in the stock market by next year. From this perspective, the Enterprise model’s 76% equity exposure makes a lot of sense.
Our portfolio actions for today are simply going to mimic part of Millennium Alpha’s rebalance and align our exposure to the winning factors that we’ve already discussed.
Automated Strategies and Market Outlooks
The Sigma Portfolio (Live)
In accordance with Millennium Alpha’s rebalance, we are closing the positions which are overlapping, namely FICO and GDDY. Additionally, we are taking profits in PANW as well. We are adding MSI to our positions, and increasing KRE and FANG in order to maximise desired exposure to Value Stocks (IVE) and the Equally Weighted S&P500 (RSP). There is no change in overall equity risk exposure.
Executing the following order at market close:
SELL 100% FICO (Close Position)
SELL 100% GDDY (Close Position)
SELL 100% PANW (Close Position)
BUY 5% MSI (Initiate 5% Position)
BUY 2% KRE (Increase position from 3% to 5%)
BUY 2% FANG (Increase position from 3% to 5%)
Click here to access our own tracker for the Sigma Portfolio and understand how the positions contribute to the overall exposure profile.
In total, we stand to gain $11.937 by risking $7.656 if our targets are correct. The risk-reward equation has improved primarily by including upside from treasuries.
Industrials (XLI), Communications (XLC) and Financials (XLF) dominate our sectors exposure, with little emphasis on the overbought defensives. We are also not emphasising the high beta Consumer Discretionary (XLY) or Tech (XLK) at the moment.
If you have any questions, please contact us using your favorite channel. Have a great week everyone, and happy investing!
Andrei Sota