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 edition of the Portfolio Rebalancing Article will be slightly abbreviated this week due to the observance of a Romanian holiday. We’ll cover the essentials for now, and save you some reading time. Let’s get started!

1. 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.

Since bouncing hard last week, stocks, bonds and gold have retraced a good part of that advance in early September. While completely within the bounds of “normal market behavior”, this pullback may give some buyers a bit of pause.

The key asset class to watch, in our opinion, remains the U.S. Dollar. It’s ascent has been pressuring all of the other asset classes lower, and it is no what bulls would like to see. The good news is that technical resistance resides just above the last close price, at $29.4 on UUP. With the dollar overbought on many short and medium term metrics, there does not appear to be a lot of scope for the current “mini-correction” in equities, gold and treasuries to continue.

A stall and reverse in the dollar’s ascent is what the other asset classes need to hold support and continue the rally.

The MACD on the U.S. Dollar has reversed the SELL signal and turned it into a BUY from a relatively high overall value. This is common within a bull market advance, but it also betrays some degree of buyer attrition. A consolidation is in order, before the next leg.

Enterprise, our core strategy, is strongly allocated to various risk assets, in the detriment of cash.

Enterprise, our most conservative model, doesn’t look very cautious at this juncture. It is 2X levered up in order to make up for the time spent in “defensive” mode.

Since this model only trades 4 asset class ETFs, we use it to judge overall portfolio positioning.

Enterprise is looking to completely close its position in Equities. It will be looking for a viable SELL signal in SPY. This could come in the form of a MACD SELL crossover, which would indicate that the current rally has fizzled out.

The strategy is looking to add to both TLT and GLD on suitable BUY signals.

Cash allocation is at negative 101%. This massive use of leverage is fully intentional and is meant to compensate for periods when the strategy is under allocated. Cash will go to more normal levels (at 5-10%) when a SELL signal is triggered for SPY and the allocation is allowed to be brought to target.

2. Sector / Industry Selection

This week, there is really one Factor that we are watching. These are large cap tech stocks. One of our strategies (Nostromo) has significant capital allocated to the Nasdaq (QQQ), we’ll take a look at how this ETF is holding up.

QQQ is not yet overbought on a medium term horizon, but looks to be struggling to reach fresh all-time-highs. After the recent run, many investors are left wondering if there’s more “reward” left on the table. It certainly looks like there’s plenty of “risk” on offer. From a technical perspective, near term support sits just below the last close price, at $370.

There is an issue with an ETF like QQQ: fundamentally, not a lot of tech companies have significant upside left. We would rather be picky with our tech exposure at this point (NVDA, MSFT, NOW - a couple of names in the Sigma Portfolio directly linked to this trade, that we like). We also own a hefty QQQ position that only serves “trading” purposes and is not a long term hold at this juncture.

Nostromo, our tactical allocation model, is looking to completely close out the position in QQQ. The order will be issued on a MACD SELL signal, as this would be the most reliable technical sign that the rally has failed.

The model remains leveraged 1.5X, with a combination of equities and bonds at the moment.

On the treasuries side, Nostromo is looking to sell TLT, on the next signal, and instead diversify into various other bond types (TIP, LQD, IEI).

Cash stands at a negative -51%.

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. 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.

As a contrarian indicator, sentiment works best near extremes. Right now, with a score of 40 / 100, market participants are jittery and showing signs of “Fear”. Not “Extreme Fear” as of yet. Ideally, if one were looking to allocate to the equity market, a lower reading would be preferred.

Neutral Signal in Sentiment

In terms of Z-Score divergence, we are not getting any performance pickup from the broad market vs SPY. Investors are hiding in the liquidity and safety of large and mega cap companies, creating the record performance gap you can see below. A healthy bull market is not the effect of a handful of giant corporations, but rather broad based participation. That participation is currently lacking.

Bearish Signal in Market Internals Z-Score

Low transaction volume continues to be the norm on the pull-back as well as on the rally. Current prices seem to not warrant a lot of trading between market participants, as each is content with his positioning. Very low realized volatility (lower panel) has a nasty habit of spiking higher when you least expect it to - something to ponder.

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.

Our strategies have increased risk exposure to the max. There is no need to act further in our real life Sigma Portfolio for now. This market can go either way.

Automated Strategies

The Sigma Portfolio (Live)

In The Sigma Portfolio, we are maintaining an elevated risk profile, similar to our automated strategies. But we are not going anywhere near their level of leverage for the moment.

Our mix of instruments creates a favorable correlation profile which does not need to be changed. We are in a waiting pattern for the moment, as the rally that started last week needs to prove itself. Support needs to hold and the dollar needs to soften a little.

If events manifest contrary to our thesis, we are ready to reduce exposure when our stops get hit. We’ll keep you posted with our Trade Alerts.

Using our Portfolio Tracker, we can determine our exact Sector / Factor exposure for the equities part of the portfolio as seen below.

In terms of Factors, the trades are creating an even exposure to factors as seen below.

You can access this correlation distribution for your portfolio as well by setting up the Portfolio Tracker.