Portfolio Rebalance / August 30
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.
Our strategies are becoming more committed to equity risk as various signals confirm the reflexive rally is working. From the more conservative Enterprise, to the highly aggressive Horizon, all of our models are dumping cash and going all-out on various asset classes. In today’s article, we’ll explore if this risk-on stance makes sense, and how we can apply it in our own portfolios.
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.
According to our analysis, all major asset classes are technically investible at this point. We are seeing a reflexive rally take hold in each of them.
After markets got extended in mid-July, a rather normal corrective period has occurred. The pullback was healthy and cooled extreme sentiment, reaching “Fear” levels.
At the very bottom of this pullback, our models initiated an aggressive risk asset allocation. They are trying to position ahead of a reflexive bounce that could take markets to relative highs (and the dollar to relative lows). We explore each, below.
SPY broke through the 50-DMA, but is now hitting against the immediate resistance level of R2, at $449; we are now getting the confirming MACD BUY signal, triggered by a positive crossover; this validates our strategies approach to heavily allocating to risk assets last week.
Commodities have bounced off support and are headed to yet another test of resistance at $24.8 on DBC.
Gold is no longer treated by our system as an alternative to equities but the drivers remain similar. The logic is 3 fold: both equities and gold represent inflation hedges. Both would benefit given lower yields. Both have technically outperformed recently.
Similar to the rally in equities, gold has managed to bounce in a reflexive manner from its own support area. It is likely headed higher in the near term, completing a retest near $183.
Meanwhile, the U.S. Dollar remains the key to this market. With momentum topping, it is about to trigger a MACD SELL signal, which could coincide with a breakdown below the S1 level.
Treasuries have bounced off technical support ($92.4 on TLT - S3). With a MACD BUY signal in place, there is scope of a rally up to $105, at the S2 technical level.
Enterprise, our core strategy, is strongly allocated to various risk assets, in the detriment of cash.
Enterprise, our most conservative model, doesn’t look very cautious at this juncture. It is 2X levered up in order to make up for the time spent in “defensive” mode.
Since this model only trades 4 asset class ETFs, we use it to judge overall portfolio positioning.
Enterprise is looking to completely close its position in Gold. Since GLD hasn’t triggered any SELL signal, the strategy is maintaining its position.
The strategy is looking to add to TLT on a suitable BUY signal.
Today, at the close, Enterprise will be buying a 9% position in SPY, on a MACD BUY signal.
Cash allocation is at negative 100%. This massive use of leverage is fully intentional and is meant to compensate for periods when the strategy is under allocated.
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 2 weeks in order to help you compare developments (click on the arrows or thumbnails to cycle through the tables).
On a Medium-Term Trend, all factors remain in a clear negative disposition. Short term, all factors trade below the key 20 and 50 Day moving averages. The only notable exceptions on the “oversold” spectrum are Emerging Markets (EEM) and Foreign Developed Markets (EFA), which continue to trade poorly, breaking the 200 DMA as well.
Longer term, Nasdaq (QQQ) and Growth Stocks (IVW) remain extended, while the Equally Weighted S&P500 (RSP) and the Dow Jones Industrial Average (DIA) are relative laggards.
We were closely watching small caps for a performance breakout, but so far the iShares Russell 2000 ETF (IWM) remains confined in its recent range. In theory, small caps (the most economically sensitive stocks) have a ton of fundamental upside, given the “right economic environment”.
According to our analysis, the tactical opportunity continues to be in the following high-beta factors:
Growth Stocks (IVW)
Nasdaq (QQQ)
They are both relative out-performers and are currently oversold enough to warrant attention. A MACD BUY signal has triggered on QQQ today.
Here’s how we stand on the Sectors front:
We have included the last 3 weeks of tables as well, for your convenience.
On a Medium-Term Trend, Healthcare (XLV) and Energy (XLE) have recovered. This is highly encouraging, considering that just last week, all sectors were in a negative M-Trend. We expect other sectors to start recovering as well, once the rally completes.
On a short term basis, no factor is actually oversold. Most sectors have recovered nicely and are trading above key averages. Only Staples (XLP), Utilities (XLU) and Transports (XTN) seem to be lagging.
They are also the notable laggards on a longer term horizon as well. Healthcare (XLV) and Basic Materials (XLB), despite performing well on their own (absolute basis) are still lagging relative to SPY. These defensive sectors just can’t keep up in a risk-on environment. As expected, Tech (XLK), Communications (XLC) and Consumer Discretionary (XLY) remain extended to the upside.
The only tactical opportunity to note here are Transports (XTN). Last week, there were 4 ETF which looked like bouncing (XLK, XLC, XLY, XTN), and the price action since then has removed 3 out of these 4 opportunities.
Nostromo, our tactical allocation model, is adding to risk by trading a massive QQQ position at today’s close.
The model remains leveraged 1.5X, with a combination of equities and bonds.
On the treasuries side, Nostromo is looking to sell TLT, on the next signal, and instead diversify into various other bond types (TIP, LQD, IEI).
Cash stands at a negative -49%.
For more info about how Nostromo targets sectors or factors within a broader asset class, read this article. The first part sheds some light on the selection process going on in the background.
This week, we will spotlight the Millennium Alpha portfolio, our most risky model. Its holdings include AVGO and NVDA, which have been standout winners.
The latest portfolio refresh brings heavy exposure to industrials at 65% (companies like Eagle Materials Inc, Emerson Electric Company,
Caterpillar Inc) and Mid-Caps.
The portfolio’s recent drawdown is in line with the average pullback (in the last 2 years) so this may be a good opportunity to find some relative bargains in its holdings.
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.
In terms of moving averages, we are in the same holding pattern for almost a year, with no notable breakout (or breakdown). The broad market is still making up its mind about rallying in a significant way.
Neutral Signal in Stocks trading above their 200-day Moving Averages
As a contrarian indicator, sentiment works best near extremes. Right now, we are very near a “True Neutral” reading, with the score being 47/100. This instrument can’t help us now.
Neutral Signal in Sentiment
In terms of Z-Score divergence, SPY is pulling back up from the broad market and creating an even larger performance gap. So far, we haven’t seen any performance pickup from “most stocks” that suggests this gap will close significantly any time soon. This is not bullish.
Bearish Signal in Market Internals Z-Score
Low transaction volume continues to be the norm on the rally as well. Interestingly enough, volume is even lighter on the rebound than it was on the way down. Market participants are content with their positioning.
Neutral Signal in Average Dollar Transaction Volume and Volatility
5. Trading in the Sigma Portfolio
After reviewing all of the above factors, it’s time to decide on the actual investing strategy for our real-life portfolio.
Since our strategies not only continue to maintain a leveraged approach, but are increasing risk exposure, it’s time we do so as well, in our real portfolio. We have already taken steps in adding more risk last week. We also need to “make up” for our time spent defending against declines, so it’s fine to add a bit of leverage.
Automated Strategies
The Sigma Portfolio (Live)
In The Sigma Portfolio, we will be rebalancing Treasury exposure at today’s close so that the overall bond duration in lengthened. We are swapping short term bonds (SHY) for the longer dated treasuries (TLT), while keeping the overall allocation the same, at 32%.
We are also adding a 20% trading position in QQQ, in keeping with Nostromo’s initiative. While our fundamental work has revealed a lot of QQQ correlated stocks have reached their Price Targets, this is a technical trade meant to speculate on short-term price movement. QQQ still presents a good opportunity, and it’s triggering a BUY Signal today.
Overall, these are the orders:
SELL 5% SHY (Reduce Position to 8%)
BUY 5% TLT (Add 5% to Position)
BUY 20% QQQ (Initiate 20% Position)
For more conservative investors, we would suggest waiting for a better entry point in terms of adding risk to portfolios. Use the rally instead to rebalance holdings and cut losers short.
Using our Portfolio Tracker, we can determine our exact Sector / Factor exposure for the equities part of the portfolio as seen below.
In terms of Factors, the trades are creating an even exposure to factors as seen below.
You can access this correlation distribution for your portfolio as well by setting up the Portfolio Tracker.
