Portfolio Rebalance / April 26
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.
This week features risk-off sentiment finally hitting the broad market, with all indices taking a dive throughout yesterday’s session. Horizon has already reduced exposure to equities, with all other strategies targeting less risk as well. With weaker seasonality coming up, and a rally that appears to be running out of steam, being a bit more conservative seems like the right approach currently.
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.
No notable change in the way asset classes are set up this week, with the swoon in equities not really registering either as a breakout in Treasuries or as a breakdown in Commodities or the Dollar;
The US Dollar keeps hugging the lower unadjusted Trend-Line; despite all the bearish headlines, selling pressure has not really materialized past this point. In this sense, the dollar’s resilience is a counterpoint to equity bulls, who would expect the reserve currency to fall in the event of a further rally in stocks.
Of course, this scenario hinges on the strong negative correlation that the Dollar has maintained to most asset classes.
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).
There is no change in the overall environment yet. The current swoon in asset prices is offering support to the Dollar, which is not breaking lower as many would have expected. With the Fed poised to raise interest rates next week, and possible selling momentum gathering steam in risk assets, we see the negative correlation continuing for the time being.
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 54% 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 $389).
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).
This week, weakness persists in Small Caps (SLY), Emerging Markets (EEM), and the Equally Weighted S&P500 (RSP). These factors are coming under pressure as a result of the regional banking crisis affecting small businesses and the public companies that have exposure to them. Weakness in the dollar is pushing Foreign Developed Markets (EFA) to become grossly deviated to the upside. Profit taking is likely in that area of the market, but it would represent a buying opportunity if EFA pulls back significantly.
By using our proven selection criteria (Z-Relative > 0, while Sigma 50 < 0), the factors that are technically buyable are:
Foreign Developed Markets (EFA) - after a pullback
Emerging Markets (EEM) - on BUY signal
Charts Emphasis:
Foreign Developed Markets (EFA) in absolute terms, with technical levels, Small Caps (SLY) breaking the M-Trend (and neckline) of a head-and-shoulders pattern.
Here’s how we stand on the Sectors front:
We have included the last 3 weeks of tables as well, for your convenience.
Sectors are showing a varied pattern, with pockets of the market rather extended -Tech (XLK), Communications (XLC) - and other areas coming under pressure -Real Estate (XLRE) and Financials (XLF). Neither extension is overly done at this point, as Tech has pulled back from the grossly overbought condition, and Financials are no longer as oversold as they used to be. There could be a rotation in progress which would see tech lose out and Energy gain.
There are no sectors that fit our selection criteria for a technical play at this point. Only XLK and XLC are relative out-performers, and we need them to trade a bit lower before considering a buy. Remember - this rally has been driven by high beta outperforming sectors, prone to profit taking at this point.
Charts Emphasis:
Market leader, XLK, pulling back from recent highs.
Nostromo is targeting EFA and EEM factors, as they fit our selection criteria. It may sound confusing that Nostromo is selling EFA today, but that’s an example of different systems doing their work. In other words, Nostromo likes EFA, but it’s waiting for a better entry point. Same with EEM, which was closed previously last week.
The Nostromo Strategy
Nostromo, our tactical allocation model, is targeting equity risk exposure via 2 Foreign Market ETFs.
The strategy would buy Emerging Markets (EEM) and Foreign Developed Markets (EFA) on BUY signals. It is selling EFA today, and aiming to buy it back at a better price.
On the treasuries side, Nostromo plans to allocate towards TLT (Long-Term Treasuries) on the next BUY signal.
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 would like to screen for stocks that are suffering significant pullbacks, despite showing fundamental strength. We call this the Beaten Up + Quality Screener.
The screener rules are:
Piotroski F Score => 6; this ensures the “Quality” component
Current Drawdown of 50% or more from All Time High; this represents the “Beaten Up” component
Additionally, we are filtering for:
MACD Trend is Positive (despite the 50% drawdown)
Z-Score Relative => 0;
Operating Leverage => 1
Out of the 9 stocks that the screener outputs, we find notable research opportunities in the following: PYPL, ORGO, LGND, GLGI.
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 rebalanced positions this week, and has slightly reduced overall exposure by issuing sell signals in all positions.
Cash is now a more significant portion of the portfolio, at 32%.
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 a reduced divergence between SPY’s Sigma Score (0.48 this week vs 1.58 last) and the Broad Market’s (-0.14 this week vs 0.28 last). SPY has closed the gap down significantly, with the divergence measuring 0.62 now vs 1.3 last week. This is much more sustainable, but the measure is still too high for our liking.
The bearish “head-and-shoulders” technical formation taking shape in the number of stocks trading above their 200-DMAs looks to be completing. It will be important for “neckline support to hold at 430-450 issues. Otherwise, breadth will become very concerning for further recovery efforts.
Bearish Signal in Stocks trading above their 200-day Moving Averages
The market is no longer oversold. It is not yet overbought either, and we can see the graph turn lower with the risk-off mood. This indicator works best at extremes, and now there is little it can offer us.
Neutral Signal in Stocks Overbought / Oversold
In terms of Z-Score divergence, the bearish difference persists, at levels lower than last week. At 0.6 now vs 0.87 last week, SPY is well ahead of the average stock (0.09 this week vs 0.24 last). This is representative of a narrow market, reliant on the performance of a couple of stocks (Technology, Communications, as noted in the Sectors part). The widening divergence does not make for a healthy bull market, but this problem seems to be resolving itself for now, with SPY closing the gap lower.
The same “head and shoulders” formation can be witnessed in the lower panel, for the average stock’s Z-Score.
Bearish Signal in Market Internals Z-Score
Dollar Transaction Volume is still sitting below average. This is a good sign in a downturn, signaling there is limited interest in transacting at lower prices. Surging volume on lower prices would be concerning.
Volatility has turned higher, on yesterday’s outsized move, but we don’t see a trend reversal yet.
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 models have diverged this week, despite having the same overall targets. Nostromo and Enterprise have no exposure to equities at the moment, and Horizon’s risk profile is also reduced.
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)
The Sigma Portfolio has a reduced risk profile currently, with treasuries able to hedge most of the equity risk. Pure cash sits at 18% of portfolio value, which is a little high. We’d like to put this cash to work sooner rather than later by pursuing the next opportunity in equities or treasuries, whichever breaks higher decisively.
For now, this portfolio is at target. There are a couple of positions flirting with their stop levels (ELV, UNH, ADM), but none have been violated so far.