Recognizing strength and weakness among primary asset classes is the core goal of our 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. During the second half of Q3, domestic equity began gaining traction vs. both cash and fixed income and is currently the strongest asset class in our relative strength and trend ranking. It will be interesting to observe whether US equities can put in a sustained move through the end of 2016, as previous strength over the past 12 months or so has tended to dissipate quickly. The asset class rotation the global markets have exhibited over the trailing four quarters has been above the norm and tends to precede large moves in the underlying indexes. Current allocations and brief thoughts are provided for your review. Please don’t hesitate to contact us with any comments or questions.
Domestic Equities: (63%) After a post Brexit rally, the domestic markets slowly churned from late July through September. Our largest positions continue to be concentrated in the Nasdaq 100 (NASDAQ:QQQ) at 15% and the S&P Equal-Weighted ETF (NYSE:RSP) at 12.5%. The mid-cap weight (NYSE:MDY) was raised mid-quarter to an 8% allocation. The most recent sector buy came last week as a 5% allocation was initiated in Basic Materials (NYSE:XLB). Materials traded well through August and became an attractive risk/reward trade on their September pullback.
Fixed Income: (0%) Given the current sub-1.75% 10-year UST, the Tactical Trend strategy does not currently have an allocation to fixed income. While much of our cash is short-term Treasury equivalents, the lack of a significant coupon is frustrating, as the risk/reward scores do not dictate an aggressive trading position at this time. It should be noted that the inverse 20+-year Treasury ETF (NYSE:TBF) has had a rising relative strength score, which may provide the strategy with a target if we do indeed see follow-through on higher domestic interest rates.
International Equity: (9%) Post-Brexit, the international equity markets have shown increasing relative strength. The strategy continues to own a 5% Japan small-cap allocation (NYSE:SCJ) and added emerging-market exposure with a 4% position during the third quarter. Both positions exhibit strong relative strength and trend scores, and our overall international equity weighting may increase in the near future.
Commodities: (0%) A frustrating asset class for the Tactical strategy in 2016 as we have missed strong trades by looking for deeper pullbacks in both precious metals and natural gas. An asset class that normally rewards patience on the entry point has toyed with our buy points thus far. We are empty-handed bulls in both areas and will continue to look for a strong risk/reward entry.
Cash: (28%) At current yields, I hate cash. Unfortunately, for much of the year cash has generated strong relative strength scores vs. the competing asset classes. The strategy must respect the analytics and has remained defensive to the detriment of performance. There have been multiple situations in past market cycles when I have experienced similar frustrations with cash levels. Often, the early warning signals eventually proved correct, but it is always an aggravating experience in the meantime.