Portfolio Rebalance / 09 January

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.

Welcome to the first Portfolio Rebalance of 2024! If you are new here, reading this article will put you up to speed with the latest metrics collected from all over our platform and the way to interpret the results and apply this knowledge to real life investing. This weekly exercise is especially healthy for managing risk, spotting trends and keeping on top of the markets in general.

With the year starting off on the back foot, Monday’s bounce in equities came as a saving grace. If “stock market astrology” is anything to go by, the first 5 days of January have provided a positive finish. “So goes the first 5 days, so goes the month, so goes the year” is an old Wall Street saying. Let’s see where that leaves us at the moment…

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.

*Equities, Treasuries and Gold are investible; Commodities have not managed to retrace out of the recent slump and remain off limits to our models;*

Technically, the market is hitting against the high trend-line once again, is overbought (93/100) and would need an additional push above previous highs in order to truly signal a “breakout”. The R3 level at $470 offers some support, but we don’t view that as significant at the moment. Trend following strategies employed by CTA funds will interpret Monday’s bounce as “bullish” and will be inclined to buy any weakness. With the short term trading range getting very narrow, we expect a break in either direction to trigger a rather large price move.

For SPY, upside remains at $477, while immediate support stands at $470. In the medium term, further support should be found at $455, where the R2 level and the 50-DMA currently reside.

*The MACD Signal is reaching extreme values, ushering in a new era of “trend-following”; since 2021, “range trading” strategies have been the only ones providing positive returns;*

Commodities continue to slump, mainly because oil remains under pressure. Macro headwinds, “global growth concerns” and weak demand from China are spurring major exporters like Saudi Arabia to enact price cuts in order to boost demand. The technical outlook is not good, despite DBC being heavily oversold.

Gold has enjoyed a lot of bullish tailwinds recently, especially as yields have come under pressure (the non-yielding metal faces stiff competition from short term government paper when it comes to the “safety trade”). We can identify a pivot level at around $186 that could either provide support for a bounce or accelerate a retracement toward support at $179.

TLT remains trapped in its consolidation zone, between $97 and $100; the benchmark long dated treasury ETF appears to be losing some steam after its stellar run from late October. Support should be close, at $92, where the 50-DMA currently resides. As CPI data is reported on Thursday, we’ll be watching the correlation with the equity market. A “cool” CPI print might not be as bullish for the stock market as many would think, especially if we see bonds bid up and stocks sold off.

Enterprise (our core investment strategy) is only holding equities (70%), treasuries (25%) and gold (2.8%). Commodities have been excluded from the portfolio for the time being as DBC is deemed uninvestable.

This model has been maintaining a healthy exposure to the equity market, remaining in “risk on” mode. It has achieved a live-trading all-time-high on December 27, as all components of the portfolio rallied. Since then, it has lost a bit of ground.

There are no major exposure changes done for today. Adjustments are very subtle to all positions, indicating that the strategy is “comfortable” with its allocation.

Since this model only trades 4 ETFs, we use it to judge overall portfolio positioning. The allocation appears balanced and adequate given current trading conditions.

Cash exposure is minimal, at just 1.6%.

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.

January 09 Factors

December 19 Factors

December 13 Factors

December 06 Factors

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).

All equity factors are enjoying a positive medium term trend. This kind of positive correlation among all ETFs is more indicative of a market topping process than a buying opportunity. Anyone remember the same table from late October when all factors were experiencing negative trends for the 6’th week in a row? Well, this is a similar set-up but in reverse.

In the short term, it’s the the Dow Jones Industrial Average (DIA), Value Stocks (IVE) and the Equally Weighted S&P500 (RSP) which are abnormally overbought. Longer term, there is no factor that stands out as being exceedingly bid.

Emerging Markets (EEM) look to be lagging quite badly, while Foreign Developed Markets (EFA) are the most relative oversold versus SPY. Will 2024 be the year where world stock markets make a come-back? It remains to be seen.

The recently launched Factor Returns Dashboard allows a different take on which factors are most correlated with high returns on different time periods. In the short term periods, companies with a high Price to Sales have enjoyed the best returns. Along with a high R&D spend relative to sales and profits, we surmise the market has bid up companies that are “long duration assets”. Expensive now, to generate returns in the future.

Longer term, Earnings + FCF Yield as well as Margins dominate the rankings. As the economy has gone through an inflationary period, it makes sense that the companies with the most pricing power have come out on top. Interestingly, Earnings Yield, the nr. 1 factor associated with 2 year performance only scores on position 27 for the past 2 weeks. Buying opportunity here?

Another factor we are especially looking out for are small caps, represented by the iShares Russell 2000 ETF (IWM). More specifically, we are focused on a breakout above $201, as the biggest opportunity in 2024 appears to be the valuation expansion of economically sensitive stocks (currently suffering from relative under-valuation).

Here’s how we stand on the Sectors front:

Sectors January 09

Sectors December 19

Sectors December 06

Sectors November 17

We have included 3 former tables from previous articles, for your convenience.

All sectors with the sole exception of Energy (XLE) are enjoying momentum tailwinds and positive medium term trends.

Financials (XLF) and Healthcare (XLV) are overbought in the short term. Healthcare is the real surprise here, as the defensive sector usually does not have the profile required to become overbought when the market is hot, being a low beta position. Let’s visualize that 2 standard deviation price move by pulling up the absolute chart:

In the grand scheme of things, Healthcare (XLV) has been range bound for the better part of 2 years. Given the previous under-performance, the current rally is not very concerning. Keep an eye out for the most correlated companies with XLV, which still look to have sizable upside (you can find these below the ETF chart):

Longer term, Financials (XLF) and Communications (XLC) round up the “overbought” list, with Energy (XLE) the clear under-performer.

There is no obvious tactical play at the moment. Technically, Financials (XLF) are “breaking out” at the moment, with what appears to be a confirmed move above $37.

Nostromo has completely exited the market after getting a sell signal for SPY in late December.

Our tactical allocation model has been performing poorly as of late, unable to generate any meaningful outperformance and “outflanked” at every turn during the past year. Nostromo “zigged” when it should have “zagged”.

It’s something we need to accept in working with any stock market strategy. Nothing works 100% of the time.

On the equity side, Nostromo is targeting SPY for allocation on a positive BUY signal. For treasuries, the strategy aims to buy TLT, also on the next BUY signal. In the meantime, cash is the only holding of this model.

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.

If “trend following” becomes a viable strategy again, Nostromo will do very well in 2024.

3. Individual Stock Selection

The Millennium Alpha portfolio has reached a brand new ATH on December 27, as the equity market rallied.

Positions like Broadcom Inc (AVGO), Dorian LPG (LPG) and United Rentals Inc (URI) have not only driven returns but also diversified the portfolio accordingly, given the completely different industries these companies operate in.

Recently, we’ve introduced an awesome Ranking Instrument that allows you to go in depth and customize the logic that selects stocks for the Millennium portfolios. Using this tool, you can apply our extremely powerful process to a subset of the stock universe that meets your investment criteria.

For example, let’s say we’re only interested in generating investment ideas for pharmaceutical companies (and prepare for a tactical allocation in case XLV has a breakout). We’d open the page and select “PHARMACEUTICAL PREPARATIONS” from the Industry selection box.

The result is a ranking like the one you see in the table below, containing the top Pharma stocks (according to Millennium Alpha). What’s more, you can also tinker with the ranking system and easily get a custom selection. If you send a screenshot of your setup over to us, we will also backtest the selection process for you. A video explaining how this works is coming soon!

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.

Monday’s bounce also bought positive news on the breadth front. 768/1000 of the top companies by transaction volume are now trading above their respective 200-Day Moving Averages. In the past year, this metric has been very much range bound, with the record being set at 778 issues in February 2023. A breakout, even if small, would contribute to an improved technical picture where “this time is different”. And by “different” we do mean different from previous outcomes, where as soon as the top of the range was reached… a reversal immediately occured. For now, this indicator remains neutral.

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

As a contrarian indicator, sentiment works best near extremes. We're down from “Extreme Greed” levels at the moment, but the market is still quite optimistic.

The highlighted period, in November - December 2022 offers a good roadmap for how we see developments next. Market movements do not happen in a straight line, of course, but, sooner or later, sentiment will normalize. It’s not a question of “if” just of “when” and “why”.

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).

This is one of the investment themes that will define 2024. Will small and mid caps finally outperform? For now, the trend is slowly moving in the right direction. Ideally, we’d like to have a market where all stocks rise, not just a select few. The October to January rally has mostly favoured large caps, as investors are still seeking the safety and liquidity that comes with owning a large cap stock.

Bearish Signal in Market Internals Z-Score

Weekly Dollar Transaction Volume is neutral, indicating average interest at current price levels. Volatility remains in check, with 3 sessions in the past month registering an absolute change larger than 1 standard deviation (+/-1.14% on SPY).

Suppressed realized volatility is indicative of investor complacency, however.

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.

We are running the Sigma Portfolio on the defensive at this juncture. The market has done nothing wrong, and despite many measures suggesting a higher than normal risk of a correction, we need to remain partially allocated to risk exposure.

We are patiently waiting for a better entry point into the broad market, and until this manifests, we will judge each position by its own risk-reward and adjust accordingly. The same goes for the allocation to bonds. We are aiming for a longer duration portfolio (more TLT), but are waiting for a better opportunity to deploy capital.

Our models are 76% allocated to risk overall, having pulled back from previous readings above 100%.

Automated Strategies and Market Outlooks

The Sigma Portfolio (Live)

Our profit taking campaign started in early December continues this week by closing out the position in Amgen Inc (AMGN). In just a couple of weeks, Amgen has shot up almost vertically and there’s very little upside left up to our price target ($316).

We will replace the lost exposure resulting from this sale by adding a position in XLV, the ETF most closely correlated with the stock’s movement. Despite the fact that net exposure remains the same, swapping a single stock position for an ETF is a defensive move.

We have also updated all stop targets in the Portfolio Tracker. Click here to access our own tracker for the Sigma Portfolio and understand how the positions contribute to the overall exposure profile.

Raising stop levels and making the aforementioned swap increases our defensive profile in a “hot” market, while maintaining upside.

In total, we stand to gain $11.445 by risking $6.132 if our targets are correct. This is a fair risk-reward profile, only attainable by careful position selection and increased stop targets.