Portfolio Rebalance / February 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.
Note: The Sigma Portfolio Tracker has a new home in the pre-release version of our new app! You can access it here.
Lots to cover in today’s article, so we’ll get right to it. First of all, investors have suddenly turned bearish according to the American Association of Individual Investors (AAII). The percentage of bears in its survey increased sharply from 40.5% at the prior reading on February 19 to 60.6% now. This represents more than a 2 standard deviation move, going back to 1987.
The other five times bearishness was above 60%, the average return six months later was +14.26%, increasing to +22.35% for twelve months, according to Sentimentrader. The market was positive in all instances, looking out for a full year.
The surprising part about this reaction from investors is that the market (SPY) is only down about -4.5% from all-time highs. Yet the AAII sentiment reading is akin to going through a serious and protracted bear market.
For now, our analysis indicates that the market gyrations are more of a supply and demand dynamic. Decreased bullish options flows (calls bought + puts sold) both in the short and in the medium term have been recorded, as options dealers and market makers were primarily responsible for the cascading selling;
This type of selling is especially encountered when negative GEX values are recorded, and especially when all of the negative gamma exposure comes from short-expiry options (2-3 days in the case of SPY)
Market makers hedge their positions by buying or selling the underlying asset (e.g., stocks or ETFs like SPY) to remain delta-neutral. When market makers are net short gamma (meaning they’ve sold more options than they’ve bought), their hedging activity amplifies price movements in the underlying market. As the market moves in one direction, market makers’ hedging activity pushes it further in that direction.
We can see the breakdown of total GEX exposure for major S&P sector ETFs below, as well as for SPY itself — which is most negative out of all ETFs.
While retail investors are skittish, corporate bond investors appear unperturbed. Credit spreads, or the yield premium an investor gets paid for taking the credit risk of corporate bonds, are at record-low levels. In other words, they harbor few economic concerns.
Bonds have nevertheless soared given both the policy uncertainty (read: tariffs) and persistent growth concerns. The Trump’s administration’s yardstick used to be the performance of the S&P 500. The President viewed stock market performance as a sort of referendum on his leadership. Accordingly, investors thought that Trump would do everything he could to backstop the stock market if it fell.
Today, the environment seems to be completely different. Per Bloomberg:
Trump has famously obsessed with the stock market as a real-time referendum on his presidency. But now, with Musk and Treasury Secretary Scott Bessent in his ear at the start of his second term, much of the attention has shifted to another benchmark — the 10-year Treasury bond yield.
Trump’s fortune was made in real estate. As a businessman, he is acutely aware of the importance of interest rates on economic activity. Trump, with the guidance of Treasury Secretary Scott Bessent, might be more focused on lowering long-term interest rates than propping up the stock market. They must first get bond investors to reduce or eliminate their fears of high deficits and inflation — most likely using the DOGE initiative. These fears manifest themselves in the bond term premium. If the Trump plan effectively reduces yields, those writing puts on bonds or outright long bonds may benefit.
With slowing momentum in the market, our automatic strategies have adapted to heightened volatility. Let’s break down all the major components of today’s investing landscape and decide on our positioning going forward.
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.
SPY broke through 100-DMA support in all of 2 hours before yesterday’s market close. Now, the benchmark ETF is starting to trade at more reasonable prices relative to our price target. Remember that back in December 2024, we set a year-end 2025 price target for SPY of $640. At the time, this was at the low end of analyst expectations. Let’s recap December’s enthusiasm:
Ed Yardeni, Yardeni Associates: 7,000
Deutsche Bank: 7,000
Bank of Montreal: 6,700
UBS: 6,600
Evercore ISI: 6,600
RBC: 6,600
Wells Fargo: 6,500 — 6,700
CFRA: 6,585
Morgan Stanley: 6,500 — (with a 7,400 bull case)
The mean Price Target was 6.687 for the S&P 500, significantly higher than our own target for SPY. From current close prices, given there are 306 days left to the end of the year, the CAGR to our conservative target is around 10.6%. This makes investing SAFE, even if moderate growth conditions prevail and there’s no economic recession.
Gold (GLD), by far the best performing major asset class over the past year (+40%) has become extremely overbought and extended. While we are fans of the yellow metal, especially given geopolitical uncertainty, we would rather wait for a pullback in order to add exposure.
TLT has surged during the last period, acting as an efficient hedge to equity positioning. Technical limits have been reached, though, with the benchmark ETF now very close to its resistance level of $92 (R1).
Enterprise, our core investment strategy, has reduced exposure in the last period. This has had the expected advantage of capital preservation during the drawdown period.
We are keenly looking forward to the rebalancing session next week, when a new allocation is computed. The strategy’s most recent drawdown is an enviable -0.3%.
Meanwhile, the 51% cash buffer is acting as a volatility hedge, which is totally adequate for an active strategy in the current climate.
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. What we’re especially interested this week to analyze are relative-to-SPY returns.
Over the past week, a clear rotation play has been in the works. Foreign Developed Markets (EFA) and Value Stocks (IVE) have been the beneficiary of rotation flows, down -0.76% and -1.95% respectively over this period. In contrast, the heaviest losses have been encountered in Growth Stocks (IVW) and the Nasdaq (QQQ), down -6.19% and -6.88% in absolute terms.
Momentum is Negative across the board for domestic ETFs, both in the medium and short terms. With the average for the Stochastic indicator at 25, and 3 ETFs below 1, technicals are in a dire condition.
No ETF is now trading above its Z-Absolute value of 0 (that represents the middle of an asset’s un-adjusted technical trading channel). Only relative-to-SPY strength is recorded for both the foreign ETFs (EFA, EEM), as well as the Dow (DIA), Equally Weighted S&P500 (RSP) and — surprisingly — Momentum Factor ETF (MTUM).
While a reasonably aggressive bounce may be probable in Growth and Nasdaq stocks, our own rebalancing process will gravitate towards the winners of this rotation.
Here’s how we stand from a Sectors standpoint:
Generally speaking, the low beta sectors — Staples (XLP), Healthcare (XLV) and Real Estate (XLRE) — have been the winners over the past week. Tech (XLK), Transports (XTN) and Consumer Discretionary (XLY) have lost.
We’ve seen this picture many times in the past. The fact that Tech leads a sell-off, while Staples and Healthcare rise isn’t exactly a new set-up. It’s the lagging in both consumer-related sectors (XTN and XLY) that’s concerning.
From an options market perspective, Consumer Discretionary (XLY) remains vulnerable, with significant downside to the short term put wall. Real Estate, healthcare and Staples look safe by comparison.
Yesterday’s options flows (Calls bought + Puts sold) favor Industrials (XLI) and Communications (XLC) + Staples in the medium term. Utilities (XLU) look vulnerable.
3. Individual Stock Selection
Millennium Alpha has undergone a hefty drawdown recently (-6%), with most stocks correlated with Growth and Momentum factors, both of which came under pressure.
While the overall allocation is balanced in terms of sectors, we need to acknowledge that this is a high-risk model, especially in the short term. Nevertheless, over the last 3 months, the performance has matched the market.
There are still 2 weeks left to the next portfolio refresh, and we can check the real-time scoring using the Ranking Model here.
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 deteriorated at the 20-DMA level, but is holding up rather well at the 50-DMA and the 200-DMA, as shown in the graph. This can also be construed as the market having more downside ahead before eventually bottoming.
Neutral Signal in Stocks trading above their 200-day Moving Averages
As a contrarian indicator, sentiment works best near extremes.
Despite the AAII survey, our own indicator is not at Extreme Fear levels just yet. While it IS indicative of “Fear” at the moment, the caution here is that we could see further lows develop.
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.
So far, SPY has declined more than the average stock during this phase. Our interpretation here is one of resilience. If economic weakness was indeed a major issue, we would see the broad market decline more than SPY.
Bullish 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.
At today’s portfolio rebalance, we will strictly be adjusting Price and Stop targets. Doing this regularly ensures that we keep a solid understanding of our risk-reward balance, which, to be frank, was not great coming into February.
Perhaps this is the only silver lining to be had. Seasonality had already indicated losses in the second part of February, and these have certainly manifested. Fundamental upside has been reinvigorated, however. Given the high and mechanical nature of volatility in today’s markets, we are not inclined to trade straight away. The market will eventually settle on a trend one way or the other and today’s sharply positive close speaks volumes as to the bipolar nature of day-to-day trading.
We are very much inclined to buy bonds on any dip.
Automated Strategies and Market Outlooks
The Sigma Portfolio (Live)
The Sigma Portfolio Tracker is available in here. Overall, our volatility profile has decreased last week, in anticipation of this correctionary period.
In total, we stand to gain $17.915 by risking $12.644 if our targets are correct. The risk-reward equation has much improved, given the fall in prices.
Our Factors exposure is almost perfectly balanced. Only Emerging Markets (EEM) have a meaningfully lesser correlation.
If you have any questions, please contact us using your favorite channel. Have a great week everyone, and happy investing!
Andrei Sota