Portfolio Rebalance / May 17
Following the Signal Sigma Process
Tuesday is the day when all of our strategies rebalance their asset class holding weights. The approach to this article follows the step by step process described here.
We are introducing a brand new instrument that combines 3 previous functionalities: The Peer Finder, Multi-Chart and Instrument Comparison Chart are now a single tool: Peer Finder & Combo Chart; This instrument is useful for charting two relevant groups of stocks and comparing the resulting equity curves; it is utterly awesome and we’ll be using the functionality in the article today;
The market has been grinding away in a correctionary process that has resulted in a lot of headlines and little price action. We may be close to the end of this period, however, as signs are emerging that the current balance will be broken. It remains to be seen weather in a bullish or bearish manner, but we will study both sides in today’s article.
One thing that has caught our attention is the fact that the Sectors driving the market higher over the last period (XLK, XLY, XLC, which also have the highest Beta-to-SPY) are hitting up against technical resistance. If the market would go higher from here, these Sectors need to maintain their performance and close the gap with Defensives (XLU, XLP, XLV).
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 and Treasuries continue to be investible, while Commodities are now trading firmly below the lower channel trend-line. Gold has become investible as well, since the upside deviation is now less extreme than before.
The US Dollar has bounced off of its lower Trend-Line, and is highly overbought according to our measure (right side of the chart). There appears to be limited upside to the dollar currently, although the positive Medium-Term trend makes us think UUP will actually test resistance at $28.36.
We are constantly checking for a break in the current negative correlation regime between the US Dollar (white) and every other asset class, combined (orange).
While there is no change in the overall environment just yet, we are noting a prevailing short-term channel that is trending in the same direction. The overall picture reflects a US Dollar with plenty of room to rise in the short-term, with the combined asset classes taking a dive - with more room to drop.
Bonus Chart: a comparison between all ETFs that we track (including commodities and bonds - orange) and all of the stocks in our database (around 2700 names - white). This goes to show how the broad market is diverging from high liquidity instruments.
Enterprise keeps allocation unchanged from last week.
The Enterprise Strategy
Enterprise, our most conservative model, is entering the week 15% long Treasuries, and 85% in CASH.
Since this model only trades 4 asset class ETFs, we use it to judge overall portfolio positioning.
Equities are targeted for exposure at 48% of portfolio value (similar to last week), via SPY ETF. The position will be filled when SPY triggers a BUY signal without violating M-Trend support (now at $388).
The model’s treasury allocation is underweight for the time being, and is meant to be increased on the next available BUY signal (from 15% currently to 20%).
At 85% Cash is still the dominant position for this model by far.
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 weeks in order to help you compare developments (click on the arrows or thumbnails to cycle through the tables).
Small Caps (SLY), Mid-Caps (MDY), Momentum Factor ETF (MTUM) and the Equally Weighted S&P500 (RSP) remain under pressure this week as well. The performance differential to SPY is maintained, as shown in the chart below.
Nasdaq (QQQ) and Foreign Developed Markets (EFA) are enjoying very high deviations, which really make us think how far these companies can push the market in the near future. These high-beta tech companies have almost closed the performance gap to SPY.
From a fundamental perspective, there could be an additional 17-18% upside to analyst price targets, with statistical potential gain about the same, when looking at individual names. However, these companies are not performing nearly as well as the ETFs they are correlated to.
Finally, when comparing the overbought factor ETFs to the oversold ones (QQQ + EFA vs MDY, SLY, MTUM, RSP), we can see that performance has fully caught up. From here on out, if the market is to continue rising, it needs participation from ALL of the stocks, not only the select few large caps.
Finally, there is no Factor that fits our selection model for a Technical play at this point.
Here’s how we stand on the Sectors front:
We have included the last 3 weeks of tables as well, for your convenience.
Energy (XLE), Financials (XLF) and Utilities (XLU) lead to the downside overall. Energy is particularly oversold in the near-term, as the very large Sigma deviation shows. Communications (XLC) and Tech (XLK) are the undisputed leaders of this rally and pushing into extremely overbought territory; it’s important to put these extremes into perspective, however.
Energy (XLE) and Utilities (XLU) have been outperforming for a while and are “catching down” to the market. When comparing to Tech (XLK) and Communications (XLC), we can see that these sectors at extremes are in fact converging.
There could be more upside and momentum to Tech, and more downside for Energy at least until an equilibrium point is reached. It’s also worth noting that XLK and XLC are now the only two sector ETFs that satisfy a basic momentum rule: have both 6 and 12 month returns positive!
Finally, there is no Sector that fits our selection model for a Technical play at this point.
The Nostromo Strategy
Nostromo, our tactical allocation model, is targeting equity risk exposure via SPY. No other Sectors or Factors qualify for inclusion at this point.
On the treasuries side, Nostromo plans to allocate towards TLT on the next BUY signal.
The strategy is staying 100% in cash at this point.
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.
3. Individual Stock Selection
This week, we’ll run both a stock screener and the Peer Finder & Combo Chart to find outperformers in the Energy sector (given that Energy is fairly oversold in the short term). We’re looking for XLE correlated stocks, with strong Z-Relative scores and solid fundamentals that outperform their Peer Group.
Our picks from the screener would be XOM, CIVI and MPC - these stocks satisfy most of our rules and cumulatively outperform their Peer Group, as seen in the chart.
We can use the Fundamental Explorer instrument to take a deep dive into their financials. Then, use the Valuation Wizard to generate a Price Target, and see the target on a chart using Technical Analysis. We might uncover some potential candidates for our portfolio!
The Horizon Strategy
Horizon has refreshed its portfolio, with a new batch of screened stocks. This month, the following positions will make up the equity portfolio: BLDR / TGLS / PAA / MYRG / RRC / CIVI / RMBS / EQT / FTI / TDW.
As seen in the second screenshot, our momentum strategy is leaning towards heavy exposure to Energy and Industrials on the sectors side and Mid-Caps and Momentum on the factors side.
On the treasuries allocation, Horizon has maintained exposure to TLT.
This model has performed poorly as of late. It’s equity curve is more related to the Momentum Factor ETF than SPY. Momentum has lagged the broader market, and has touched previous-low levels.
As an aggressive equity exposure model, Horizon has got trapped in repeated “bear-market rallies”. Eventually, those will end sooner or later and this model will start performing closer to its historical metrics.
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.
This week, we are noting cracks form in the broad market, from multiple vantage points. While SPY is trading in a tight range, stocks in the broad market have come dangerously close to breaking the “neckline” in “Above 200-SMA”. However, that does not mean anything just yet, since no break has actually occurred.
Neutral Signal in Stocks trading above their 200-day Moving Averages
The market has proven resilient, with yet another downturn that does not break below the lower levels this indicator has recorded recently. Our sentiment reading is very useful at “real” market extremes. We’re at neither right now.
Neutral Signal in Stocks Overbought / Oversold
In terms of Z-Score divergence, the bearish difference persists, at similar levels to last week.
The same “head and shoulders” formation can be witnessed in the lower panel, for the average stock’s Z-Score. It is not showing any signs of a breakout or breakdown currently.
Neutral Signal in Market Internals Z-Score (leaning bearish)
Dollar Transaction Volume is sitting below the recent average, with suppressed volatility. Given the “hovering around recent highs” condition of SPY, this indicator is starting to lean bearish, as the impetus of buyers becomes exhausted. Low volatility has the nasty habit of turning into high volatility rather quickly.
Neutral signal in Average Dollar Transaction Volume and Volatility (leaning bearish)
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.
Our models continue to diverge this week, despite having the same overall targets. Nostromo and Enterprise have no exposure to equities at the moment, and Horizon’s risk profile remains subdued.
To start, we will take an average of CASH position sizing from all of our models. This will come down to 72%, with a wide 85% - 35% allowed. Equity exposure stands at 16% on average, while on the treasury side models average 11.6%.
Automated Strategies
The Sigma Portfolio (Live)
We recognize both the bullish and bearish aspects of the current market. On one side, we have an avalanche of bearish headlines, recession indicators and fragile economic indicators. On the other, we have a resilient stock market, that “has not done anything wrong yet”, neither at the index level, nor at the broad market level.
Sooner or later, this condition shall be resolved one way or another. We are taking an action today to clean up our portfolio using the “Removals” section of our Portfolio Tracker. The ADM position has not worked recently and has violated our technical stop level. We are replacing it with similar themed companies in the Basic Materials / Energy sector, without affecting the overall allocation of the portfolio. Executing the following trades at today’s market close:
SELL 100% ADM (Close Position)
BUY 2% XOM (Initiate 2% Position)
BUY 1% ALB (Initiate 1% Position)