Portfolio Rebalance / January 16
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.
As anticipated, short-term conditions in the equity market had reached oversold levels, transforming any better-than-feared news into a catalyst for a rally. Such was the case today, after the Consumer Price Index (CPI) for December was reported.
Specifically, the data featured a slight dip in the year-over-year rate for core CPI to 3.2% from 3.3%. Annual inflation rose for a 3rd consecutive month to 2.9% in December 2024 from 2.7% in November, in line with market expectations. While not a rosy report by any means, we can assume that the market was pricing in worse numbers.
The immediate reaction was a sharp turn lower in treasury yields. Most notably, the 10-yr note yield, which is most sensitive to changes in inflation, is down 12 basis points to 4.67%. This is a challenging long-term yield to deal with, however, and presents an unappreciated risk for relatively high valuations.
Higher yields act as a braking force on economic activity. When combined with an exceedingly optimistic outlook for 2025 by Wall Street analysts, the risk of disappointment becomes high. Stocks are nearly “priced for perfection”, with asset prices far exceeding what a slowing economic growth rate is likely to support. This creates minimal margin for error. In essence, investors are placing substantial bets on corporations' flawless execution at a time when macroeconomic uncertainties remain significant.
Even accounting for the latest market decline (which is entirely benign at the moment), median valuations for S&P 500 companies stand at levels practically unseen in the current cycle (save for the post-pandemic boom). While valuations are NOT a good market timing indicator, they give us a broad understanding of where we are in a larger context.
When adjusting SPY’s chart for our $640 price target and 19% CAGR slope, the result is still expensive (read: “risky”) looking. So if our main asset allocation model is reducing exposure - maybe it’s time to listen.
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.
Only Equities and Gold are investible this week, with Treasuries and Commodities far below required levels for long positioning.
As hinted at above, SPY was able to maintain its short term support at the 100-DMA, and has so far “done nothing wrong”. The benchmark equity ETF has exited official “oversold” conditions, but the 20-DMA has recently crossed below the 50-DMA, as overhead resistance mounts up to $604.
Commodities (DBC) have rallied massively since last week, putting them in the investible category again. The margin is slim, with our stop-loss level close by, but bear in mind that commodities have been in a massive bear market. Prices today are equal to those last seen in early 2022.
Out of all major asset classes, commodities (DBC) have the highest potential to rally, whereas Gold is very near its ATH records.
With that being said, Gold (GLD) has also recovered from its recent technical support and looks to complete its consolidation pattern. We are bullish on the yellow metal in 2025, and think it has a definite place in investors portfolios.
Lastly, TLT remains uninvestable, despite today’s rally. Interest rates have surged sharply amid concerns over potential "tariffs" under the new administration. Additionally, stronger-than-expected economic data has raised fears that the Federal Reserve may pause further rate cuts. It is worth noting that the rise in rates is largely driven by short-term sentiment, as the broader economic data continues to follow a longer-term mean-reversion trend.
We expect bonds to ultimately recover.
Enterprise, our core investment strategy, has slammed the breaks on risk-taking, preferring a more diversified approach.
Stocks exposure via SPY has been slashed from 84% last week to 42% now.
Bonds exposure (IEF) continues to be 0%.
The position in GLD has been increased, from 3% to nearly 5%.
Commodities (DBC) are now included in the portfolio, at a significant weight - almost 15%
Since this model only trades 4 ETFs, we use it to judge overall portfolio positioning. With Gold and Commodities at 20%, Cash at 38% and Stocks at 42%, we would call the current stance as “balanced - defensive”. We tend to agree that this is the right approach for the next period.
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’ll use the new Time Machine feature in Signal Sigma V2 to compare the same metrics between last week (January 6’th) and today, while trying to spot emerging trends.
Emerging Markets (EEM) and Foreign Developed Markets (EFA) continue to trade poorly, having extended their short term drawdowns. Mid-Caps (MDY) have proven resilient, as have Momentum (MTUM) and growth related stocks (QQQ, IVW).
On a longer timeframe, Foreign Developed Markets (EFA), Emerging Markets (EEM) and Value Stocks (IVE) stand out as the major losers and factors to avoid. A positive Relative Z-Score is now enjoyed by just a couple of factors, which have stayed afloat during the last bout of weakness: Mid-Caps (MDY), the Dow Jones Industrial Average (DIA), Equally Weighted S&P500 (RSP), iShares Russell 2000 ETF (IWM) and Momentum Factor ETF (MTUM).
Momentum remains generally weak, with most factors close to recording “Oversold” conditions. The only silver lining is that a couple of factors are starting to generate positive short term MACD crossovers since last week.
The pocket of strength is now easy to identify: mid-caps, small-caps, momentum and Dow stocks are favored going forward.
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 two dates (Jan 14 / Jan 6).
Energy (XLE) has seen by far the biggest move to the upside during the past week, with many other sectors also recovering. There is also a definite improvement in the normalized deviation from the 20-DMA — last week recorded a -0.19 average, which now stands at -0.02. So momentum is clearly present in the short term, with 5/12 sectors trading above their 20-DMAs.
In the longer term, Basic Materials (XLB) got their well deserved relief bounce (+3% on the week), heavily reducing the downside deviation, but still remaining the worst-off sector. Energy (XLE) has also pivoted to a relative outperformer, following it’s near 4% weekly rally.
While Transports (XTN), Consumer Discretionary (XLY), Utilities (XLU) and Financials (XLF) remain best positioned overall, Communications (XLC) and Tech (XLK) have slipped, with investors preferring to rotate out of the mega cap names which are heavily weighted there.
When looking at the Overbought / Oversold metric (Stochastic 40D) in comparison to last week, flows from Tech (XLK) and Communications (XLC) to Energy (XLE), Healthcare (XLV) and Basic Materials (XLB) are also apparent.
Notably, no sector is overbought yet, but we are seeing some good recovery efforts in short term momentum. Last week, only 3/12 MACD signals were positive, while now that number stands at 7/12.
3. Individual Stock Selection
Millennium Alpha has executed its monthly rebalance and refresh, with only a couple of changes. Note the very broad diversification on the sectors pie chart this week, with 10 sectors being represented (we agree with this approach at the moment). On the factors side, Momentum (MTUM) still dominates.
Additions:
Removals:
On another note, the strategy’s drawdown now matches a 2-year through (but on a longer timeframe, it’s barely a blip).
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 been resilient at the 200-DMA, but absolutely decimated for the 20 and 50 day averages. The average stock in the market has been more resilient than SPY, judging by its Sigma Score (-0.17 vs -0.32), so that is a plus. For now, this looks like a bullish development.
Bullish Signal in Stocks trading above their 200-day Moving Averages
As a contrarian indicator, sentiment works best near extremes.
Sentiment has touched “Extreme Fear” on 2 market days so far and remains fragile. This indicator is closer to the “BUY ZONE” than the “SELL ZONE” and shows that (if required), it’s not a bad time to increase risk tolerance. However, our read is that sentiment has not spent enough time in “Extreme Fear” to truly revert bullish psychology. Contrarian positioning may still be too early here. We’ll chalk this up to “Slightly Bullish”.
Slightly Bullish 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.
Z-Score deviations have recently deteriorated for both large caps and the broad market. The divergence itself has moved in favor of the broad market, but only by a fractional amount. This indicator is stuck in “Neutral” for now.
Neutral Signal in Market Internals Z-Score
Dollar Transaction Volume is just about average at the moment. Considering that we are in the middle of a consolidation, this is not very good news, but it could be worse if volume was higher. We’ll see how volume responds to an eventual recovery rally, but this indicator is also “Neutral” at the moment.
Neutral 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.
Our analysis this week dictates that excess risk-taking is not optimal at this juncture. For an investor that is not allocated to risk assets at all, buying makes sense, of course. But in our case, we own about 75% stocks versus a target of 60% - so this translates to an overweight positioning. We need to use the post-CPI “relief rally” to move closer to our target this week.
Furthermore, it appears that Millennium Alpha is favoring a well-diversified approach. Given that several well diversified factors are outperforming — Mid-Caps (MDY), Equally Weighted S&P500 (RSP) for example — we agree with this positioning. As such, we’ll be reducing both general exposure by raising cash and rebalance to a less concentrated sectors / factors exposure.
Automated Strategies and Market Outlooks
The Sigma Portfolio (Live)
Here are the orders for today’s close:
SELL 100% LLY (Close Position)
SELL 100% MSI (Close Position)
SELL 100% FICO (Close Position)
SELL 100% UTHR (Close Position)
SELL 100% CDNS (Close Position)
SELL 2.5% META (Rebalance to 5% weight)
BUY 5% HALO (Initiate 5% Position)
BUY 5% RL (Initiate 5% Position)
BUY 5% MPLX (Initiate 5% Position)
BUY 5% DBC (Initiate 5% Position)
The Sigma Portfolio Tracker is available in here. Overall, our volatility profile has been reduced compared to last week due to the near 10% reduction in our stocks allocation.
In total, we stand to gain $15.326 by risking $9.388 if our targets are correct. The risk-reward equation nets out at +$5.937, or 5.48% of our total NAV, which is an “ok” ratio.
Our optimisation this time around was for a more balanced exposure profile, not so much the risk / reward ratio. Take for example our Factors exposure:
As well as our Sectors exposure:
Both are much more balanced than last week!
If you have any questions, please contact us using your favorite channel. Have a great week everyone, and happy investing!
Andrei Sota