Note: this week’s article will include both our Weekly Preview and Portfolio Rebalancing notes; our editorial focus is taking the back seat for now, as we gear up for the launch of Signal Sigma V2 (Alpha Version) on Friday.

Window Dressing After Profit Taking

During the past week, the market traded in a sloppy manner, as fund managers and many other active investors chose to take profits. Since profits can only be harvested from positions which have appreciated in value, it was momentum stocks which disproportionately got hit. Whatever went up in 2024 has been slammed during the past week, especially on Monday’s session, which saw a 3-standard deviation down-move in high-beta stocks:

These kinds of sharp, one-day losses are characteristic of high performance assets and models that invest in them (unfortunately). As a consequence, both the holdings in our Sigma Portfolio and Millennium Alpha models have declined significantly, as can be seen in the performance charts, especially at the 3 month interval.

The current drawdown of our various strategies are entirely correlated with the amount of Momentum Factor exposure. The hardest hit was Millennium Momentum — as the name implies — down -9.5% from all-time-highs. Meanwhile, the limited volatility Millennium Vol Target is only registering a -2.5% decline.

The good news is that such periods are often reflective of supply and demand dynamics, and rarely signal meaningful changes from either a technical or a fundamental perspective. While some selling pressure such could persist until early this week, we should be getting close to the end of the distribution and rebalancing process which led to this imbalance in the first place. The fact still remains that by the end of 2024, most managers will want to be owners of the hottest stocks in the market — if only for “portfolio window dressing” purposes.

In other words, the recent correction paves the way for a “Santa Claus Rally”. The optimistic and modern interpretation is that this seasonal trend implies steady increases during the last two weeks of the year, associated with the Christmas Holidays. The original saying is a bit more menacing: “If Santa Claus should fail to call, bears will come to Broad and Wall.”

But — that is a problem for 2025.

Technically speaking, the market is trading at the upper end of its risk-reward channel and should be well supported at $590 (50-DMA). A short-term bearish MACD Signal could exert more downward pressure on stocks this week and there is a risk of the market declining toward the 20-DMA by the time the Fed announces its next rate cut on Wednesday.

However, barring any unexpected events, the market should be able to rally into year-end with a target of $610 to $615 (if not quite to our immediate upside target of $631).

Generally speaking, the market should do fine into the first week of 2025 as well, since the main drivers remain in place: share buybacks, bullish sentiment, and seasonal tendencies. However, as the new administration sets in, all bets are off. If a radical transformation (shrinking) of the U.S. Government is to take place (Argentina-style) — while great in the long run — it would imply short term economic pain.

Speaking of sentiment, our own Market Internals reading is showing a surprising deterioration. At the moment, there are slightly more stocks oversold than overbought (lower panel), which is highly atypical with headline index values near all-time highs (SPY is just -0.59% below its record close).

A similar analysis shows a growing divergence between the performance of the average stock in the market and the SPY ETF. While 50-DMA and 200-DMA trends are healthy, only 34% of stocks could maintain trading above their 20-DMAs. In the lower panel, the difference in technical extension is large, with SPY recording a 1.19 total Sigma Score and the average stock recording precisely 0.

We would normally interpret these gaps as bearish signals.

On the positive side, dollar transaction volume conditions are above average, as liquidity has improved during the consolidation period. This will act to suppress volatility and support higher prices, all things being equal.

On another optimistic note, the NFIB released its latest small business confidence index, which surged after Donald Trump’s election victory. After remaining at levels typically associated with recessionary economies over the last three years, the latest reading suggests a massively positive shift in business owners’ outlooks. That shift is a function of expectations in several areas:

• Tax rates will not rise as the Tax Cuts And Jobs Act of 2017 will be made permanent.

• There is a potential that corporate tax rates could be cut from 21% to 15%.

• A reduction in regulatory overreach from the previous administration.

• The reduction of illegal immigration and the institution of legal pathways for immigration.

• A reversal of the abandonment of the “rule of law.”

• A shift in policies that will support U.S.-based businesses and encourage domestic production.

• Expedited permitting for U.S.-based business development investments.

However, it should be noted that small business owners are excited about proposed government initiatives, not actual implementation that also carries risk. For example, immigration restrictions might solve crime-related problems, but increased costs and labor shortages may also surface as a result.

For now, we’ll take the excitement at face value, as it may spur CAPEX spending from small businesses and that’s a net-positive effect. However, there could be a risk of disappointment here that we can’t ignore. Finally, the market did great during the pessimistic years of 2023 and 2024, as the dour outlook left room for improvement.

Our Trading Strategy

Millennium Alpha will refresh and rebalance its portfolio on Tuesday. We will wait until that time to see the new portfolio composition and then adjust our equity exposure to around 75% and possibly include some of the new picks. A major decision will be made regarding bond exposure as well, with TLT trading very near our stop-loss target.
There are a couple of more positions that need our attention (looking at you, AMD) but we’ll handle those on Tuesday. We will issue a Trade Alert email separately.

Meanwhile, we are very excited to put the final touches on our first release of the brand new Signal Sigma platform. We are aiming to make it available to you on Friday. This will be an “alpha” version, with a lot of missing functionality and possibly a number of bugs. But as it is, it will bring an increased functionality to the current platform and give you a pretty good idea of what we are building.

With your feedback, we hope this product can grow into an indispensable investing tool that will bring you more certainty in your investing and — of course — profit!

Signal Sigma PRO members will be notified by Trade Alert of any live portfolio changes (if subscribed). If you’re not on this plan yet, you can get a free trial when you join our Society Forum. If you need any help with your trading strategy (or would like to implement one on your account), feel free to reach out!