By Matthew McAleer, Managing Director & Portfolio Manager
Recognizing strengths and weaknesses among primary asset classes is the core goal of our Tactical Trend strategy. The strategy seeks to identify relative strength and trend strength in an attempt to allocate capital to the strongest asset classes while underweighting or eliminating exposure to the weaker classes. The asset classes tracked include US equities, international equities, fixed income, commodities, and cash.
Through Q4, US equity markets continued to strengthen at the expense of bonds as the steady move higher in rates from the July low (1.35% 10-yr. UST) added perceived and real risk to fixed-income capital. International equity continued to be challenging, as gains tended to dissipate quickly. This has been an ongoing challenge in the international markets, as the trends, while positive, remain fairly weak. Commodities were led by solid moves in oil, gas, and industrial metals. Current allocations and brief thoughts on each asset class are provided here for your review. Please don't hesitate to contact us with any comments or questions.
Domestic Equities: (70%) The Q3 relative strength continued as the market churned higher until the strong post-election spike created more demand and markets caught a strong bid. The largest broad exposure in the portfolio continues to be in the Nasdaq 100 (QQQ), S&P (RSP), and the Mid-Cap 400 (MDY).
Our sector allocations currently include consumer discretionary, consumer staples, basic materials, energy, and a new, small allocation to biotech that was entered as the sector showed some signs of relative strength early in the quarter. That position, while showing early signs of RS, will have to follow through with more demand to remain in the portfolio. Broad healthcare (XLV) was exited, as it could not regain post-election momentum.
International Equity: (15%) A very frustrating asset class, as the trends and relative strength were improving nicely through early Q4 but weakened post-election. Emerging markets have been dominant throughout the year vs. developed markets. It remains to be seen whether that trend continues, as EM has struggled over the past six weeks. Our largest allocation is small-cap Japan (SCJ), while we also have exposure to broad EM (VWO).
Fixed Income: (0%) The Tactical Trend strategy does not currently have an allocation to fixed income. The weakening relative-strength scores of that class in late Q3 accelerated through Q4 as yields rallied. The momentum indicators we follow have reached oversold levels that would generally coincide with a buying opportunity on any improvement in relative strength. From a valuation standpoint, Muni bonds trading at 130% yields to taxable bonds makes them very attractive for income investors.
Commodities: (0%) A frustrating asset class for the Tactical Trend strategy in 2016, since we were shaken out of an energy trade in gas (UGA) that subsequently ran 20% after our exit. Stop losses are always a challenge in volatile securities and markets but must be respected. One of the biggest challenges an investor/trader faces is the ability to reenter a trade after being stopped out. This was the case with UGA, as it strengthened and then rallied soon after our exit.
Cash: (15%) At current yields, we continue to dislike cash and look for an asset class to complement our US equity holdings. That quest remains challenging because US equities are currently the dominant asset class and widening their relative-strength score vs. the other classes. One thing is certain: Opportunities will present themselves in 2017 in multiple asset classes. The ability to remain flexible and enter at strong risk/reward levels continues to be the backbone of our Tactical Trend strategy.
