Portfolio Rebalance / 23 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.
With markets breaking out over the last couple of days and various positive signals emerging across commodities and stocks, our automated systems have increased equity risk exposure. Are we going to follow suit? Most likely, yes.
Let’s see what corner of the market offers the best risk/reward potential.
Note: as of this writing, Millennium and Horizon Strategies have yet to complete Portfolio Rebalancing. Please check back for the latest orders.
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.
High Deviation Warning for Equities while Treasuries and Gold remain investible and Commodities continue to slump… albeit more slowly
SPY is trading at all time highs after a breakout registered last Friday, following TSM’s positive guidance. With more broad based gains and carryover momentum, we can expect the benchmark ETF to trade as high as $498 in the near term. Support sits at $463 near the R2 level and the 50-DMA. However, the “High Deviation Warning” we get from the Asset Class Overview Instrument is acting like a yellow stop light. This triggers when the instrument is trading at over 1.5 standard deviations above the unadjusted trading channel median, like we are doing right now.
The chart below is adjusted with a $508 Price Target and 12% compound annual growth rate, so the deviation appears unremarkable:
The MACD has triggered a buy signal; with the latest crossover coming from a relatively high level, upside appears to be limited; however, the signal is telling us that momentum favors the bulls in the short term;
Commodities have started basing around current low levels and have stopped declining since last week. The price action has been hardly encouraging for the broad index-tracking ETF (DBC), but individual commodities have started turning up (oil in particular). DBC has a way to go before recovering the technical damage (it has to trade above the stop level at $23.26), but it is oversold enough to elicit a bounce.
Gold has been struggling to hold at recent highs. The increase in yields that has occured in January has made non-yielding gold lose some of its luster. It is remarkable though, that the yellow metal is trading relatively high, eliciting healthy demand from both retail and professional investors as a portfolio diversification tool.
The series of higher lows since October puts a floor under GLD near the recent lows, just south of $187 (R1). Should that fail, support comes in at $180, while upside sits at $191.
TLT is struggling to maintain support at the 50-DMA, as the benchmark ETF came under selling pressure in January; it’s worth noting that the MACD signal has reached a downside extension more commonly associated with short term reversal patterns, so we can expect support to hold in this instance. If it does not, the downside could be much lower, at $86 (M-Trend).
Enterprise (our core investment strategy) maintains the same allocation as last week: 70% equities, 25% treasuries and 2.8% gold. Commodities have been excluded from the portfolio as DBC is deemed uninvestable, despite its oversold status.
This model has been maintaining a healthy exposure to the equity market, remaining in “risk on” mode for much of this breakout. Since the market has not broken its bullish bias, the strategy does what it’s supposed to do - follow trends.
There are only minor adjustments ordered for execution today.
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 2.89%.
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 3 article editions in order to help you compare developments (click on the arrows or thumbnails to cycle through the tables).
Emerging Markets (EEM) are the only factor to not exhibit a positive medium term trend, due to the troubles prevalent in the Chinese stock market. As government stimulus in China is nowhere to be seen (at least not to the extent that investors have hoped for) EEM rounds out the bottom of the pack, trailing badly across all metrics.
In the short term, most factors (7/10) are still trading below their respective 20-Day Moving Averages, which may come as a surprise given the general bullish overtones. The Momentum Factor ETF (MTUM) stands out as being the most overbought and extended currently, with a total deviation above 2. The breakout that we have flagged last week is continuing:
Longer term, all factors are generating some positive absolute performance, but in relative terms, only MTUM, IVW and QQQ are outperforming the SPY, similar to last week. Extensions in MTUM and IVW are getting a bit extreme at this point, and could run into profit-taking soon.
The recently launched Factor Returns Dashboard allows a different take on which factors are most correlated with high returns on different time periods.
A factor which has ranked consistently high among all time periods recently is the Piotroski F-Score (we are aware of the spelling mistake in the table). This is a qualitative metric, which can range from a minimum value of 1 to a maximum value of 9 and measures a company across 3 categories:
Profitability
Leverage, liquidity, and source of funds
Operating efficiency
Ranking shown for Piotroski F-Score
Interestingly, this factor dominates rankings across virtually all timeframes. We usually screen for a minimum Piotroski F-Score of 6 in many of our stock oriented strategies.
Ranking shown for Piotroski F-Score
Along with Gross Profit Margin, we find that a higher Piotroski F-Score has been associated with higher returns in recent trading.
Ranking shown for Gross Profit Margin
Here’s how we stand on the Sectors front:
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. With the S&P 500 now signaling a positive short-term crossover, we may expect this setup to continue.
Healthcare (XLV), Financials (XLF) and Tech (XLK) are short term overbought (even after accounting for the consolidation in XLF).
Longer term, Energy (XLE) is grossly oversold, while Tech (XLK), Financials (XLF) and Communications (XLC) provide leadership and positive relative-to-SPY performance.
We are still watching the iShares Russell 2000 ETF (IWM) for a breakout and still this is proving to be elusive. $197 is the level to clear, if we are going to have a broad market rally.
Nostromo, our tactical allocation model, has picked up on the MACD signal shown by SPY today. As a result, it is ordering a complete fulfillment of its targeted goal (90% equity allocation).
The strategy is also waiting for a valid buy signal for TLT in order to initiate a position in treasuries as well. While this model usually trades multiple ETFs, for now it is content holding / targeting only these basic 2.
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. During the drawdown of the past 2 years, this model has severely underperformed.
3. Individual Stock Selection
Our flagship stock picking model - Millennium Alpha - is refreshing its stock portfolio today.
Outgoing positions include BKNG, IBP, QLYS and PCAR (closed). These names are replaced with NBIX, MSI, AMGN, and META. We find META to be the most “reasonable” buy at current (high) levels.
As can be seen on the right side of the dashboard, predominant sector correlation is Tech (XLK), Industrials (XLI) and Healthcare (XLV) for this portfolio. Meanwhile, for factors, we get Mid-Caps (MDY), Small Caps (IWM) and Momentum (MTUM).
Using the awesome Ranking Instrument you can 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.
We may be interested in selecting a couple of Healthcare stocks for further analysis, using Millennium Alpha’s logic. We just need to apply a Sector Correlation -> XLV filter to the ranking table, and we’ll get the following list:
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.
Moving averages have received a bump from the latest rally. Levels are healthy for what we consider to be a bull market advance.
Neutral Signal in Stocks trading above their 200-day Moving Averages
As a contrarian indicator, sentiment works best near extremes. We have bounced from a “Neutral” level to a “Greed” level, courtesy of the latest market advance.
We did not reach our intended “target” for a bounce, where this indicator would read around 40 / 100. At the moment, we would call this level of sentiment neutral, as it is not highly extended in either direction.
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).
This is one of the investment themes that will define 2024. The breakout in Small Caps has always looked like it’s just around the corner, but has not yet manifested. Until the rally broadens, this indicator cannot turn bullish. Markets are strong when participation increases and are vulnerable when just a handful of names perform.
Bearish Signal in Market Internals Z-Score
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.
With our models turning more bullish after SPY’s breakout and raising average exposure to 99%, we are prepared to follow suit and add to a couple of equity positions in order to bring our allocation to target.
Our models were 76% allocated to risk last week, now almost 100%.
Automated Strategies and Market Outlooks
The Sigma Portfolio (Live)
This week, we would like to achieve 3 goals:
Rebalance our Energy sector exposure (since XOM has been underperforming for the second week in a row);
Raise our equity exposure to target - from 54% previously, to our 60% target after the rebalance is executed;
Achieve a superior risk-reward proposition while performing this rebalance;
As much as we liked Millennium’s picks for this month, we believe there will be better entry points into many of those positions. We would like instead to capitalize on the breakout in Financials (XLF) and add 2 positions from this sector: ZION (Zions Bancorporation) and Popular Inc (BPOP).
We’ll be selling part of Exxon Mobil (XOM) and make room for Valero Energy Corporation (VLO). Here’s what the orders look like:
BUY 3% ZION (Initiate 3% Position)
BUY 3% BPOP (Initiate 3% Position)
BUY 3% VLO (Initiate 3% Position)
SELL 3% XOM (Reduce existing position to 2%)
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.
Our trades from today carry a $1.826 upside, while risking $445 - so our third objective should be satisfied.
In total, we stand to gain $11.550 by risking $5.779 if our targets are correct. This risk-reward is achieved by raising stop-loss orders so that our gains from the last 2 months are adequately protected.
Factor correlation for our stock portfolio now looks adequately balanced…
…while sector correlation is still a bit heavy on the Consumer Discretionary (XLY) side, so we’ll need to work this off in the future. Tech (XLK), Communications (XLC) and Financials (XLF) exposure is high, but not exaggerated.
If you have any questions, please contact us using your favorite channel. Have a great week everyone, and happy investing!
Andrei Sota