Recognizing strength and weakness among primary asset classes is the core goal of the Tactical Trend strategy. For much of the year, domestic equity, fixed income, and cash have registered very close scores in our relative strength analytic, which measures buy and sell signals between asset classes. This data corresponds closely with what we are seeing in the broad markets as we continue to witness choppy action without a consistent trend emerging. At various times during 2016, domestic equities, fixed income, cash, and commodities have each rotated in and out of our strongest risk/reward levels. This action is much different from the steady leadership of domestic equities and fixed income that we became accustomed to from 2012–2015. The continual change in leadership brings us back to the period we saw in 2006–2010, when nimble adjustments to capital were the norm in controlling risk.
Current allocations and brief thoughts are provided for your review.
Domestic Equity: (63%) With the sharp pullback post-Brexit, the primary indexes are testing May levels. These price points are decent risk/reward spots to play against for existing or new capital. Defensive sectors are trading above May levels and have cushioned our strategy recently. Note that with the recent move up through $51 on XLU (Utilities), we were sellers and took that position off. While we still like Utilities in a sub-2%, 10-year UST market, we feel that a reentry on a pullback is prudent in the Tactical strategy. Going into the sharp pullback, we initiated a position in MDY (mid-caps) at a decent oversold reading near the middle of the 10-week trading band.
Fixed Income: (0%) At the previously mentioned sub-2%, 10-year UST, the Tactical Trend strategy does not currently have an allocation to fixed income. While much of the cash is short-term Treasury equivalents, the lack of longer-duration bonds has been a mistake so far in 2016, as long-term Treasuries have been strong performers. A trader must learn from every trade and market cycle as each environment is different. Despite very strong relative strength readings in long Treasuries, the coupon scared us away in the strategy. Lesson learned – trust your work!
International Equity: (5%) We have fortunately been maximum underweight this asset class in 2016. The lone holding internationally is SCJ (small-cap Japan), which throughout the recent meltdown overseas continues to trade very well from a relative strength perspective.
Commodities: (5%) After a long drought, this asset class is showing solid performance. We have an initial holding UGA) and plan to commit further capital on pullbacks. Though it is often a tough asset class to trade in the ETF/ETN world, a trader/investor cannot ignore this asset class during strong cycles, as it is often able to deliver outstanding short-term performance.
Cash: (27%) The strategy has had an allocation of cash ranging between 20%–25% for much of the second quarter. Cash is the trickiest asset class to own. At current yields, I hate cash; but when it is generating strong relative strength scores, we must respect it. The current pullback will open up further opportunities to reduce the cash level.
By Matt McAleer
Managing Director & Portfolio Manager