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.

The past week has certainly been eventful. Traders awakened on Monday morning to a sea of red, caused by the Trump’s tariff saga. Markets eventually recovered and were undeterred by Alphabet’s earnings miss on Tuesday evening. By Wednesday and Thursday, it did look like the bulls were back in charge, as stocks were making steady gains, and the volatility caused by DeepSeek and the Trump Administration became “distant” memories. The week ended on a profit taking note, and we have 2 main observations to note.

First of all, stocks and long-term government bonds (SPY and TLT to be more specific) have recorded an unusually high correlation as of late. The chart below describes the SPY correlation of all major asset class ETFs at various intervals ranging from 200-Days (leftmost column) to 5-Days (rightmost column). For TLT, the high cluster of correlation between the 60-Day and the 5-Day stands in stark contrast to the longer term measures. So much so that we must start considering if both assets are now being impacted by the same drivers.

Leaving these metrics aside and doing a simple visual check reveals that indeed stocks and long-term bonds have been moving in near lockstep for the past 3 months. We’re less interested in the absolute return metrics at this point, and instead focused on the general direction of the trade in order to draw some conclusions.

First of all, both assets are in a medium term consolidation pattern, with less than spectacular returns since the start of November (near 0% in fact, if combined 50%-50% in a portfolio). We would expect the main driver for stocks to be the progression of Q4 Earnings Season. However, the bond market at the long term is almost entirely driven by inflation expectations and has little to do with the latest company earnings.

The recent alignment suggests that inflation and the Fed are a much more impactful driver for asset prices at this point than quarterly performance and guidance. This makes absolute sense given that the market carries a lofty valuation of 22.1x future earnings and that the upside to a reasonable price target ($640) implies a 6.23% CAGR by the end of the year. In other words, not a lot of upside for a hefty amount of risk.

Meanwhile, live inflation readings have plummeted and the recent jobs report published on Friday was underwhelming (143K jobs added vs expectations of 170K). We especially like to monitor the labour market through the perspective of Job Quits. The quits rate measures the percentage of workers who voluntarily leave their jobs. A higher rate typically signals that workers feel confident about finding better opportunities, which suggests a tight labor market. Conversely, a low quits rate can indicate that workers are reluctant to leave—often because job prospects are weak or economic uncertainty is high.

At the moment, we are seeing the quits rate at an average level and in a clear down-trend. This should not spark inflation worries — at least not the sticky inflation kind, especially when combined with government efficiency drives like DOGE.

Translation: buying stocks on inflation-related fears should work out, while bonds have more upside than stocks right now, in the aggregate.

The silver lining for stocks is that the Q4 Earnings Season has worked out pretty well so far. With 62% of S&P 500 companies reporting actual results, the blended (year-over-year) earnings growth rate for the S&P 500 is 16.4%, above the sandbagged expectations of 11.8%.

Given this backdrop, we can initiate our usual investment process.

1. 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.

Similar to last week, SPY is trading in a consolidation manner, with little fundamental upside but enough liquidity and risk appetite to support dip-buying. Without a more influential catalyst, we expect more of the same in the near term, with a bit more downside potential than usual.

Commodities (DBC) have transitioned into a range-bound chart pattern, from a previous bearish trend. This is a bullish development that precedes the longer term change from bearish to bullish, and commodities seem to be going through this phase. At the moment, the trade that looks to work is selling tops and buying bottoms (mean reversion). But if a breakout occurs… watch out!

Gold (GLD) is by far the best performing asset class year-to-date, with a +7.53% gain. While stocks and bonds struggled during the last 3 months, the yellow metal has surged to all-time-highs. Since we can’t really value gold on a fundamental basis, we are only left with doing some technical analysis — according to which — previous resistance at $259 now turns into support. With both short and medium trends positive, the outlook is very bullish, despite the overbought status.

TLT has flipped to “investible” in the past week, closing above our stop-loss level and now facing a true challenge: holding M-Trend support at $89 by the end of next week. $89 is also near the neutral gamma flip level, which has major implications for the volatility of this assets from a market maker’s perspective.

Enterprise, our core investment strategy, has done a hefty bit of profit taking on Thursday. This has proved to be inspired, although do expect a full re-allocation by next Tuesday’s rebalance.

Given the end-of week trading, we can’t use the model’s allocation as a guide for the longer term. We need to check back on Tuesday.

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. Momentum stocks have accelerated recently, while Dow related companies have retreated significantly compared to last week. Any cumulative value higher than 1.5 on the chart below translates into “highly overbought”, so Momentum stocks are nearly there.

Notably, no factor is oversold in the short term, with Mid-Caps (MDY) and small caps (IWM) even trading below the 20 and the 50 DMAs.

Taking a longer term perspective, we’re seeing relatively low Absolute Z-Score deviations across the board. The difference between factors is made at the Relative (to SPY) Z-Score metric, where we see Momentum excel and Value Stocks (IVE) take a huge beating. Overall, the breadth of the factors market has deteriorated slightly from last week.

When the same metrics are viewed in a scatter plot, we can clearly identify a cluster of ETFs performing very similarly (MDY, RSP, IWM, IVW and EEM), while 3 main outliers remain: Momentum Factor (MTUM) on the outperforming side, Value Stocks (IVE) at the under-performing extreme, and Nasdaq (QQQ) lagging awkwardly.

With most factors lagging on an absolute basis (X-axis) it looks like market breadth is deteriorating. But since most factors are also outperforming on a relative-to-SPY basis (Y-axis), having a more granular take on the stock market (industry or stock picking) should yield an advantage versus the benchmark index.

Here’s how we stand from a Sectors standpoint:

Same as with the Factors analysis, we’ve generated the graphics using Signal Sigma V2 and the Time Machine to compare metrics at the close of the last 2 weeks. We can clearly identify the winners of 2025 so far: Financials (XLF) and Communications (XLC), with all of the other sectors putting in some mixed performance. Energy (XLE) and Basic Materials (XLB) are lagging, but not yet oversold, in sympathy with Commodities.

However, from a medium-term options market perspective, it’s exactly the rally leaders (XLC and XLF) which have the least potential percentage gain up to their respective Call Walls. Instead, beaten down sectors Energy (XLE) and Basic Materials (XLB) are recording the best risk-reward at the moment.

Meanwhile, Real Estate (XLRE), Consumer Discretionary (XLY) and Utilities (XLU) seem prone to large pullbacks until their Put Walls are reached.

Taking a longer term perspective, we do see a potential rotation occurring from Consumer Discretionary (XLY) and Financials (XLF) to Energy (XLE), Basic Materials (XLB) and Tech (XLK).

However, we have seen more extreme deviations than what we’re currently recording, so the aforementioned rotation has the potential to be delayed to a certain extent.

In theory, Tech (XLK) makes for the most appetising target for inflows, in the case of a rotation trade, but options data is not supportive of this. Instead, we see the options market (bullish and bearish volumes) predict a more momentum driven market where XLC and XLF are favored on a strength continuation trade, while XLB bounces from oversold. Tech (XLK) is being shunned, as the relative-to-SPY chart also shows.

Remember - we are looking to trade relative strength, not weakness, despite the appearance of value.

3. Individual Stock Selection

Stocks in Millennium Alpha are primarily allocated to tech for the moment, and performance has cooled off in this model past the November 4 surge. We would need to wait for next week’s rebalancing in order to better assess the strategies’ positioning going forward.

Our thinking is that Financial stocks will start to become included due to their recent outperformance.

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 recently deteriorated, despite the resilience shown at the index level. This is not a good indication going forward, as the market needs interior strength in order to rally sustainably.

Bearish Signal in Stocks trading above their 200-day Moving Averages

As a contrarian indicator, sentiment works best near extremes.

Similar to the broader market, sentiment has “consolidated” around the Neutral reading. Technically, it looks like a “breakout” or “breakdown” comes next. Nevertheless, we’ll simply assign a Neutral reading to sentiment at the moment, equally far from any extreme.

Neutral 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.

Similar to last week, we can note:

Z-Score deviations have been moving in lockstep for a while. Mid and Small caps have performed respectably, especially post the November election, but could not hold their own recently. Market cap is not a useful factor at the moment, so we’ll assign this metric a “Neutral” reading.

However, we also added another chart, comparing Small and Mid-Caps (IWM + MDY) with Mega Caps (MGK), an even more extreme comparison. Turns out that we do see a difference, especially since early December when Mega Caps took the lead convincingly. Generally, this happens when investors seek the safety of large, liquid companies and seek to avoid the risk associated with smaller stocks.

Neutral-Bearish Signal in Market Internals Z-Score

Our Dollar Transaction Volume metric is currently experiencing an error and we are looking into it.

Error 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.

We have decided to take the first step toward a more meaningful allocation to bonds. On Thursday, we allocated an extra 8% to TLT.

For now, the equity market has “done nothing wrong”. Despite the unattractive risk-reward, there is no technical reason to preemptively cut risk exposure just yet. Instead, we’ll focus on adjusting stop levels and price targets, and swap risky assets for less risky alternatives whenever possible.

This is a somewhat tricky environment to navigate, and we will need to reassess equity market fundamental targets once Earnings Season is done. In any case, it looks like volatility is here to stay, especially from “Headline Risks”. Some of that “Headline Risks” are actually opportunities in disguise.

Automated Strategies and Market Outlooks

The Sigma Portfolio (Live)

The Sigma Portfolio Tracker is available in here. Overall, our volatility profile has increased compared to the last rebalance.

In total, we stand to gain $14.994 by risking $16.444 if our targets are correct. The risk-reward equation is not great, and we will start making small adjustments in the equity part of the portfolio to compensate for this. Part of the changes will be technical in nature, raising both profit and stop targets.

Our Factors exposure is well balanced, with just a fraction more focus towards Momentum.

From a Sectors exposure perspective, we are a bit too heavily weighted toward Tech (XLK) given our current analysis. After Tuesday’s Millennium Alpha Rebalance, we expect to make some changes, especially on this side of the ledger.

If you have any questions, please contact us using your favorite channel. Have a great week everyone, and happy investing!

Andrei Sota