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.

Our strategies are continuing to be well allocated to risk this week as well. There are a couple of changes to be mentioned, but the pullback in equities so far has not triggered any meaningful SELL decision from our systems. With the dollar hovering near an important technical inflection point, will today’s FOMC meeting tip asset markets in any particular direction? Let’s see how Powell’s press conference sets us up for the next period…

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.

Traders are unwilling to push SPY (and other equity indices) higher: the benchmark ETF is trading in its established range of $449 - $431. This is set to continue absent a bullish catalyst in the near future.

Commodities have surged recently, and the highs in oil prices are grabbing headlines. Which usually tells us that most of the move is behind us already. DBC is highly overbought in the near term, and we see the next leg as a consolidation, most likely, at the $25 level.

Gold (sometimes treated as an alternative to equities by our system) looks compelling at this stage. It has bounced off support at the M-Trend level ($178) and is currently on a MACD BUY signal.

As expected, the U.S. Dollar has stumbled at the high end of its technical range. It is still extended and overbought, and appears to be losing momentum, as signalled by the negative MACD crossover. Our systems are banking on its eventual leg lower.

Long dated treasuries are highly oversold (6/100), but are still managing to hold near support at $92.4; an inability to break down further would prove very bullish for bonds at this juncture, so watch for a “double bottom” to form.

Enterprise, our core strategy, remains levered up 2X.

Enterprise, our most conservative model, is pursuing volatility at the moment, via exposure to 3 asset classes. In other words, the model is betting against the USD.

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

There are no major changes in exposure, despite the very slight reduction in the SPY position.

The strategy is looking to sell GLD on a suitable signal. The logic here is that one of the two asset classes needs to go: either equities, or gold, since they are “competing” for the same portfolio spot. If neither trigger a signal until the next rebalance, the model will continue to be leveraged.

Cash allocation is at negative 99%. This massive use of leverage is fully intentional and is meant to compensate for periods when the strategy is under allocated.

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).

All factors register a negative Medium-Term Trend. This kind of alignment usually occurs near relative market extremes, since factors don’t normally trade together to this extent. We have noticed this setup for the second week in a row, with factors more oversold than previously measured.

On a short term basis, all factors are trading below their key 50-DMAs. The Russell 2000 ETF (IWM), the Equally Weighted S&P500 (RSP) and the Emerging Markets ETF (EEM) are all trading below their 200-DMAs as well, and look particularly vulnerable in the near term. At -2 standard deviation oversold relative to SPY, RSP (which is really made up of the same companies, just equally weighted) proves to what extent the market cap factor is outperforming.

As we’ve come to expect by now, Nasdaq (QQQ) and Growth Stocks (IVW) are the only factors that are relative outperformers compared to SPY. They are the factors holding up best both short and longer term as well.

Since both QQQ and IVW have pulled back below their 50-DMAs and are relative outperformers, our system will consider them top technical plays for a rebound.

Here’s how we stand on the Sectors front:

We have included the last 3 weeks of tables as well, for your convenience.

Sectors appear to be fraying as well. All of the ETFs that we track are now forming a negative M-Trend, except Energy (XLE).

In the short term, Staples (XLP) and Transports (XTN) look most oversold. The measures are not extreme, but they do flag both sectors as vulnerable. Communications (XLC), Energy (XLE) and Financials (XLF) are the strongest components, as they represent the only pockets of the market holding above all key moving averages.

In the longer term, Communications (XLC), Consumer Discretionary (XLY) and Tech (XLK) still look overbought, but not nearly to the same extent as during the summer months. Staples (XLP) and Utilities (XLU) lag badly, as they are defensive in nature.

Energy (XLE) and Financials (XLF) look solid from the perspective of holding out well during the market pullback. Consumer Discretionary (XLY) and Tech (XLK) are the “buy-the-dip” technical play here, as they are relative outperformers in the longer term, while trading below the 50-DMA in the short term.

Nostromo, our tactical allocation model, has diverged from Enterprise in terms of equities exposure.

It has sold a part of its QQQ position, in a bid to rebalance and distribute the allocation to IVW as well. This leaves Nostromo with just 43% equity risk exposure at the moment.

It’s also adjusting bonds positioning, by selling 21% of the TLT position at today’s close. It is looking to buy other bond ETFs like HYG, TIP and LQD.

Notably, Nostromo is highly allocated to the precious metals trade through physical silver, silver and gold miners (SLV, SIL, GDXJ). All of these positions are set to be sold on appropriate signals, so that the whole portfolio can deleverage.

Nostromo holds a negative -112% cash position, being more than 2X leveraged at the moment.

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

There are several sectors that warrant attention, if we are to consider “buying the dip” in individual names. For this, we’ll go to our specialized Buy The Dip Opportunities Screener. Here are the screener rules:

Regression Trend is Positive; the stock is trending up, on a 2 year historical window

• Sigma 50 < 0; currently, the stock is trading below the level where it’s normally been trading relative to its 50-day Moving Average

• Z-Relative > 0; the stock is outperforming its benchmark ETF

Additionally, we’ll limit Market-Cap to 1B, set the Pietroski F-Score to a minimum of 6, and only consider stocks strongly correlated to the aforementioned ETFs. 10 stocks make the list.

Notably, chipmakers AVGO and LRCX are present, as well as home builder Lennar and energy company Range Resources. The graph provides a warning, however - despite the short term oversold nature of these stocks, they look technically expensive in the longer term.

We can study their financials using the Fundamentals Explorer, and model their Price Target / EPS Growth Rate using the Valuation Wizard.

This week, we will spotlight the Millennium Vol Target Smart Beta portfolio. This portfolio has been chugging along nicely, in a very controlled manner for the past year. It’s volatility targeting feature has removed excessively risky stocks from the portfolio mix and this has helped outperformance.

The portfolio is mainly exposed to Industrials, Mid-Caps and the S&P 500 Equal Weight factor. Names like Booking Holdings Inc and WW Grainger Inc are the best performers in the group.

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.

No change from last week’s comment:

From a moving average perspective, the equity market is “stuck” within the range established since November 2022. The recent pullback has stocks trading midway through this range, but there is no other notable observation at this juncture.

Neutral Signal in Stocks trading above their 200-day Moving Averages

As a contrarian indicator, sentiment works best near extremes. We suspect that following Powell’s hawkish press conference, sentiment will start trending toward the lows, signaling a buying opportunity is in the making. For now, the market is just trading in “Fear” mode. Not “Extreme Fear” just yet. But we get a feeling it’s a matter of time until we get there.

Slightly Bullish Signal in Sentiment

In terms of Z-Score divergence, the SPY to broad market differential is persisting. However, as SPY has pulled back recently, there’s been a bit more resilience shown by the broad market. The differential seems to be tapering off, albeit from very high levels.

Bearish Signal in Market Internals Z-Score

Transaction volume remains average at best. It will be interesting to see over the next couple of days if this picks up post FOMC.

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 average system exposure remains high, topping 230%. Asset classes are well mixed, however. Nostromo is standing out by overweighting precious metals. This should act as a hedge to a certain extent, and does not represent an unilateral increase in risk exposure as suggested by the raw numbers.

Automated Strategies

The Sigma Portfolio (Live)

In The Sigma Portfolio, we are maintaining exposure to the same trio of asset classes (Equities, Gold and Treasuries), while being modestly leveraged. We have reduced exposure a bit, by taking profits in XOM recently.

For now, there is no need to act on this pullback. The plan is to add to risk exposure once the market sentiment hits “Extreme Fear”. We also like the precious metals trade here, and are inclined to add to that part of the portfolio as well.

Overall, we believe the market reaction post FOMC represents a buying opportunity into year end. We are fully aware that September is a seasonally weak period and that valid concerns exist for 2024. There is downside risk currently, as the market finds its footing, so it’s not quite the moment to be “all in”. But the market likes to climb a “wall of worry” once it’s all said and done. And there are a lot of worries out there.

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

In terms of Factors, our trades favor the growth side of the equity spectrum.

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