Portfolio Rebalance / October 11
Observations on Signal Sigma Strategies weekly positioning and transactions
Tuesday is the day when all of our strategies rebalance their asset class holding weights. This week, our systems are holding some exposure to the commodities sector, as it is the only asset class left that qualifies for an allocation.
On the discretionary management side (the Sigma Portfolio), it seems like we are forced to re-hedge, and push our exposure closer to neutral. Last week, we closed one of our short positions on the assumption that the bounce in the market will top out at around 385-400 on SPY. We are willing to hold this view for another 3 weeks, but the broad market is flirting with our STOP-LOSS level as well (360).
One worrying bit of evidence that we have indeed entered an official bear market comes from our Market Internals instrument that tracks the number of stocks overbought versus those oversold. Normally, a bull market is defined by stocks trading in an overbought state more often than in an oversold one. That is why the 2-std line for overbought stocks sits above the line for oversold stocks.
This week, we have seen the number of stocks oversold officially take over the number of stocks overbought on our indicator, as shown below:
The strength of the US Dollar has shown no respite last week, with commodities rising alongside the reserve currency (a fact also flagged by our trading models). Take the 1 week performance for each asset class:
SPY: -3.61%
TLT: -4.44%
GLD: -2.36%
DBC: +2.96%
UUP: +2.06%
It comes as no surprise then, that our models continue to heavily overweight cash (to a far greater extent) and commodities (to a lesser extent) as their preferred choice of asset class allocation.
The US Dollar (white: UUP) vs a combined asset class portfolio (orange: SPY + TLT + GLD + DBC)
While the short term performance of the Sigma Portfolio is clearly outperforming the benchmark index, it is our job to make sure it continues.
Following the path of least resistance at this point means selling single stock positions on a reflexive rally (or relative performance), and buying the broad market via hedge closure.
If a STOP-LOSS level is violated, we will use the broad market to hedge. At some point, this will lead us to a market neutral state, then net-short.
Let us observe the changes in our automated models.
Enterprise Strategy
Enterprise, our most conservative model, holds 15% exposure to commodities, and 85% cash.
Since this model only trades 4 asset class ETFs, we use it to judge overall portfolio positioning.
The strategy will not trade until next week’s rebalancing (the “To Trade” column is 0, meaning that there is no requirement to adjust any position on any signal).
Cash reserves (USD) are at 85%, a very defensive number.
Nostromo Strategy
Nostromo, our tactical allocation model is starting the week with 100 % cash positioning.
The strategy will look to buy gold (BAR) on the next available BUY signal.
This is unlikely to occur in the following trading week, as the ETF is not yet oversold, and the MACD is still positive (a MACD cross would be required in this case).
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.
Horizon Strategy
Horizon, our most aggressive strategy, will rebalance commodities exposure by closing the DBA position for a slight gain, and allocating the full commodity allowance to gold (BAR).
Favoring a risk-taking approach, Horizon will not wait for any other signal and simply allocate increase the BAR position.
The model views gold as an inverse bet to the US Dollar. Since 85% of the model’s allocation is still towards cash, a position in gold is a way to hedge that.
Takeaway:
2 weeks ago we wrote:
“In the Sigma Portfolio, we are looking to reduce equity risk exposure to 0% (be completely hedged in a long-short book). Furthermore, on a rally that takes the combined asset classes to overbought conditions (and the US Dollar to oversold) we will aim to switch to a net-short allocation.”
There is no change in our overall thinking. On the equity side, we are close to triggering a STOP-LOSS with a close on SPY below 360. If this occurs ahead of the inflation report, I would be inclined to deploy a lighter hedge, as Thursday’s data will be a huge catalyst. I do not expect a positive surprise there, but rather a very oversold market that breathes a sigh of relief while digesting “ok” data.
We have 3 weeks left to go of net-long exposure (remember, time is also a factor in the overall allocation decision).
Andrei Sota