Portfolio Rebalance / 17 November
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.
This week, we’ve decided to push the Portfolio Rebalancing process to the end of the week in order to get the maximum information available from all available events. Next week, we’ll skip this process entirely and focus on a detailed analysis of S&P 500 constituent companies. We’ll set new a new Price Target for year-end 2024 based on fundamental DCF models for the most influential stocks.
Right now, we are trading in a constructive environment, where dips are met with pretty solid bids across equity and treasury asset classes. We expect that this will be the environment in December as well, facing a bit of selling pressure around Thanksgiving. Let’s dive in!
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.
All asset classes remain investible; Commodities are showing some weakness, stemming from global economic growth concerns;
We’ll turn to a fundamentally adjusted SPY analysis, assuming our August 2023 aggregated price target and historical 7% EPS growth rate. We find that the current price is well above $436 fair value and due to supply-demand dynamics could reach up to $467 by year-end. Short term support is at $440, and while bullish underpinnings exist, 2024 might turn out to be completely different than what we’ve seen so far this year.
The MACD signal is showing overbought conditions that are due for a consolidation in the short term;
Commodities are trading directionless with a bearish bias at the moment. Technically, the break of the 200-DMA is concerning for DBC (commodity tracking ETF). Theoretical downside sits at the lower trend-line (around $22.5), some -4.6% lower than the last close. Oil is the main culprit of the price move, as it is suffering due to demand concerns, on a weak economic growth outlook.
Gold has proven to be resilient after a rejection at the R2 level and a round trip to the M-Trend. It has now bounced in a somewhat neutral technical level that we have branded as a “Pivot”, near $183. Closing higher is bullish, while another rejection here would confirm another leg lower. The exact demand driver for gold at this stage is unclear - all else being equal, lower treasury yields should help gold shine (since gold pays no dividend or interest).
The U.S. Dollar (UUP ETF) has finally broken a major support level by breaching the M-Trend to the downside and finding support near the S1 level, at $29.28. A close below this support level would set the dollar up for a sizable correction to $28.45, near the lower trend-line and March ‘23 + June ‘23 tops. It would be very bullish for every other asset class, so look out for this development.
In contrast, should the M-Trend level be breached to the upside again, then the situation becomes a bit more complicated, and we may see various asset classes react erratically.
Long dated treasuries (TLT) have a bullish bias currently, appearing to set a lower boundary for the drop in prices at around $84, where our M-Trend level resides. TLT has cleared its 50-DMA (now short-term support) and are headed for a full retracement to the 200-DMA, near $98. Momentum is clearly positive, but TLT is not overbought for now.
Enterprise (our core investment strategy) is maintaining its asset class allocation from last week, making minimal changes in the interim.
The bulk of the allocation is made up of equities (55%) and treasuries (31%) with the remainder sitting in Gold, Commodities and Cash.
Since this model only trades 4 asset class ETFs, we use it to judge overall portfolio positioning. For the moment, this is a balanced allocation, one that is adequate to the market’s current predicament.
Cash sits at 6.8% of portfolio weight, as the US Dollar starts its descent.
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).
Wow! What a change a week and a market rally makes! After a serious slump in terms of trend (7 consecutive weeks of all-negative readings), 9 out of 10 factors have now turned positive on this momentum measure. This marks a very important inflection point, as the signal in momentum measures is the “crossover” point. This is just that moment.
On a short term basis, the Momentum Factor ETF (MTUM) is sitting well above all 3 key moving averages. Nasdaq (QQQ) is not very far behind, both factors having had incredible runs as of late. There are no short term oversold factors, but the notable laggard is the iShares Russell 2000 ETF (IWM). The small-caps tracking ETF is still trading below its 200-DMA, and has just suffered a rejection at S2 Resistance, near $179.
For market breadth purposes, it’s critical that small caps start outperforming.
Longer term, Nasdaq (QQQ) and Growth Stocks (IVW) look highly extended, but that is what a breakout always looks like. These 2 factors are making up lost ground, since the large drawdowns of 2022.
There are no tactical opportunities for allocation at the moment. Fundamentally, IWM represents the highest value play, assuming a “soft landing” economic scenario that helps the whole economy.
Here’s how we stand on the Sectors front:
We have included 3 former weeks of tables as well, for your convenience.
The medium-term trend direction has shifted positively for most sectors as well. Only Energy (XLE), Transports (XTN) and Healthcare (XLV) remain in negative trend dispositions.
Energy is the sector that is performing poorly in the short term due to the drag in oil prices. On the other hand, Tech (XLK) is highly extended above all key moving averages, while Financials (XLF) are also flirting with short term overbought territory.
Longer term, Tech (XLK) and Communications (XLC) are well deviated to the upside from a relative-to-SPY and absolute perspective. Staples (XLP), Energy (XLE) and Healthcare (XLV) are the main laggards, especially on a relative-to-SPY measure.
There are no tactical opportunities present among factors. Energy (XLE) doesn’t look buyable yet, as the extension to the downside may continue. One can also reasonably expect Tech (XLK) to pull back and consolidate. Financials (XLF) and Consumer Discretionary (XLY) have a nice set-up going forward, especially if a rally is confirmed by the iShares Russell 2000 ETF (IWM) factor.
Nostromo, our tactical allocation model, is looking to take profits in all factor positions (QQQ, EEM, IVW) and buy SPY instead.
For the moment, the fact that Nasdaq (QQQ) makes up 50% of the portfolio is immensely helpful for performance. But once sell signals trigger, all of these positions will be exited. The BUY signal for SPY will not trigger anytime soon, since a rally is already well underway.
Nostromo’s 24% bonds position is mostly derived from a combination of TIPs with IEI (3-7 year treasuries) and HYG (corporate bonds). The model is looking for a BUY signal in TIPs in order to double its position from 17% to 32%. All other positions are placed on a SELL watchlist.
Nostromo is no longer leveraged, leaving up to 14% portfolio value as dry powder (cash), same as last week.
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
Our flagship Millennium Alpha portfolio just had its latest portfolio refresh this week. The most recent stock selection emphasises a diversified factors correlation, with almost equal sizing of Nasdaq (QQQ - 26%) and iShares Russell 2000 ETF (IWM - 19.8%). On the sectors side, Industrials correlation dominates, at 32.5% of positions. Tech (XLK) and Consumer Discretionary (XLY) represent the 2 other important areas of focus.
Among individual names, we find some familiar Sigma Portfolio stocks:
Nvidia (NVDA)
Microsoft (MSFT)
WW Grainger Inc (GWW)
Amgen Inc (AMGN)
Millennium Alpha is also nearing its all-time high watermark.
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.
510/1000 stocks we track are trading above their 200-day moving averages, vs ~450 last week. We are now back to trading in the range established since November 2022, which is definitely good news. We need to keep seeing market breadth stabilize and prove that late October was an anomaly. Note the large difference in Sigma Score between the average stock and SPY, telling us that this is still a market driven by a few stocks.
Neutral Signal in Stocks trading above their 200-day Moving Averages
As a contrarian indicator, sentiment works best near extremes. Just 3 weeks ago, the market was trading in “Extreme Fear”. Since then, we’ve seen a blistering rally, in a nod to a market that looks increasingly bipolar. Right now, sentiment reads “Greed”, at 65 / 100. We’ll get to “Extreme Greed” above 74, when it will be time to take some profits. Bulls would rather see some consolidation first.
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). In this “bounce” episode, we can see the divergence rising again, as the market is buoyed by mega cap stocks. The rally has not broadened at all in the last week, and reversed the previous trend in divergence. Mega cap leadership is on the rise again, in a moment where small caps need to rally and close the performance gap.
Bearish Signal in Market Internals Z-Score
Dollar Transaction Volume is neutral. We’ve emphasised the previous episode of correction and recovery in order to compare the realized volatility. Note that the volatility regime has totally shifted to the downside in the most recent drawdown. This is clearly bullish, as traders have stepped in to buy the dip.
Bullish 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.
Our positions continue to experience a balanced risk-reward profile almost to the dot. Using our Portfolio Tracker, we’ve managed to determine that the upside is equal to the downside at this stage. Since we are looking for profit opportunities to exceed the potential for losses, there is no need to add to positions right now.
Instead, we are watching for 2 key factors:
IWM breakout - a bullish catalyst that would get us to rebalance toward small-caps; a breakdown would make us scale back these bets;
“Extreme Greed” sentiment, triggering a profit taking session in the most overbought of instruments;
For now, none of these catalysts exist, so there is nothing to act upon. The portfolio has tracked and outperformed the SPY/TLT benchmark nicely over the last 3 months, and is set to differentiate even more in the months to come. Average system exposure of 85% confirms our overall stance.
Automated Strategies
The Sigma Portfolio (Live)
Our latest trade alert from earlier this week reads:
With the mellow CPI print behind us, SPY is trading right up to our isolated resistance level of $449.
While we are fully allocated to "risk-on" names, there is a very interesting -10% dip in one of our energy picks that we'd like to trade opportunistically - RRC (Range Resources).
We are also slightly increasing our bond duration by swapping 2% from SHY (1-3 yr bonds) to TLT (20+ yr bonds)
Executing the following orders in the Sigma Portfolio at today’s close:
BUY 2% RRC (Add 2% to Position)
SELL 2% SHY (Sell 25% of Position)
BUY 2% TLT (Add 2% to Position)
In aggregate, our positions now have a balanced risk-reward profile. As the market rises further, we will be looking to book some profits.