Due to an issue with our nightly data pull, some international models and mutual funds have not finished updating. These issues should be resolved by midday. We apologize for any inconvenience.

Beginners Series Webinar: Join us on Friday, October 2nd, at 2 PM (ET) for our NDW Beginners Series Webinar. This week's topic is Utilizing the Models Page. Register here.

Upcoming Webinar with KraneShares: Join Brendan Ahern, KraneShares CIO, and Ian Saunders, NDW analyst, as they discuss the long-term outlook for New Economy secular trends, what is changing in China from a technical perspective, and how to apply an objective approach to investing in China through the NDW KraneShares Dynamic China Rotation Model. This webinar will be run by KraneShares, and will take place on Tuesday, October 6, from 11am to 12pm ET. Click here to register.

Although not as extreme as Q2 of this year, the third quarter of 2020 was generally a positive one for the major asset classes covered in this piece as each posted an average gain from June 30th – September 30th. Beginning with domestic equities, despite the second highest average group return of 7.73% a notable performance gap remains across and within the space. Note that the two momentum representatives, PDP and DWAS, are the top performing ETFs as both tend to benefit from high dispersion (clear leaders and laggards) within their respective universes. Also noteworthy, the end of Q3 pushed SPY to its best six-month return since 2009 (Source: wsj.com).

Perhaps more surprising, international equites notched the best average group performance for the quarter with a gain of 8.55%. Similar to the domestic equity space, a developed momentum fund, PIZ, led the charge with a gain of 12.31%. Broad emerging markets EEM also ran a good race, and with several tailwinds still in place from last quarter the group pushed over 10% higher. Commodities saw positive returns as well with broadening participation, averaging together for the third highest quarterly return just under 7%. We saw the dollar trend lower for most of the quarter, UUP posting a loss of -3.29%, and fixed income remain relatively steady with BND falling just 0.14%.

Deeper and more detailed discussions will follow the asset classes mentioned above in next week’s report.

After a strong start to the third quarter, September lived up to its reputation as one of the worst months for stocks as the S&P 500 SPX was down -3.92% for the month, while the Nasdaq NASD was down just over 5%. Despite the recent volatility, US equities remains atop the DALI asset class rankings after reclaiming the top spot in late August. It is followed in the second spot by fixed income, while cash currently ranks third. DALI helps us to identify where strength (or weakness) resides across, as well as within, the broad asset classes. One of the goals of the DALI strategies is to overweight the strongest asset classes in the market and underweight the weakest. Before we look at the performance review let's revisit the various DALI strategies.

DALI Allocation Strategies

• DALI No Bogey: One of the most basic strategies, DALI No Bogey, assumes owning the top two ranked asset classes in an equal-weighted fashion.
• DALI with Bogey: Like the DALI No Bogey strategy, DALI with Bogey owns the top two ranked asset classes, but it also employs the Cash Bogey Check. If one of the two asset classes “Fails” that Cash Bogey Check, cash replaces it in the portfolio allocation.
• 3 Legged Stool: The 3 Legged Stool Strategy, as the name implies, consists of three slices. Two of the slices (or legs) are allocated to the top two asset classes emphasized in DALI, and the third leg is designed to be a constant equity exposure. Within this strategy, the managed equity exposure can take on a different meaning for each, but it is one way to further customize DALI by using individual stocks, ETFs, mutual funds, UITs, or a combination of all.
• DALI Tactical Allocation: The Tactical Allocation, or 6 Legged Stool as this strategy has come to be known in some circles, is a strategy where 15% of the portfolio is allocated to Domestic Equity, International Equity, Commodity, and Fixed Income. That accounts for 60% of the portfolio. The other 40% is split between the top two emphasized asset classes in DALI. This has the effect of maintaining exposure to four asset classes at all times and then using DALI to know which asset classes to overweight.
• DALI Flexible Allocation: In the DALI Flexible Allocation Strategy, each asset class is weighted in the portfolio based on the percent of total "buy signals" the asset class maintains relative to the current sum of "tally" signals. In this strategy you are maintaining exposure to all six asset classes at all times; however, depending on where the strength is in the market, you will be overweighting and underweighting different asset classes at different times.
• DALI Tactical Tilt Allocation: Our Tactical Tilt program was designed to begin with a strategic target in mind, perhaps something along the lines of 60% stocks and 40% other "stuff" and then establish ranges within which the portfolio can adapt. As our research over the past years has proven, those ranges must be wide enough to allow real adaptation to take place, but narrow enough to avoid the common complaints of "purely tactical" portfolios. In a sample moderate "Tilt" allocation, an offensive portfolio could have 75% exposure to US Equity while a sample defensive portfolio could be only 20% US Equity and 60% Fixed Income.

Click here to go to the DALI Strategies Page for current suggested allocations.

This is certainly not an all-inclusive list of DALI strategies, as there is a multitude of portfolio methodologies that can be built around DALI's guidance; however, the strategies mentioned above are designed to provide basic frameworks as to how DALI might be incorporated into an overall portfolio. In the evolution of DALI testing and strategies, the "Tactical Tilt" process has been one to gain much traction. It offers a happy medium between traditional strategic allocation and pure tactical asset allocation. Once the minimum weightings in each asset class based on strategic boundaries are satisfied, the remaining portfolio allocations are filled beginning with the strongest asset class in DALI up to that asset class's maximum. Once the maximum weighting for the top-ranked asset class is achieved, then you would simply fill the second-ranked asset class, and so on until 100% of the total allocation is achieved. Therefore, using the "Moderate Tilt Allocation" as an example in the current market, 20% would go to domestic equities to fulfill the minimum requirement, 5% to international, 20% to fixed income, and 0.5% to cash. The remaining 54.5% is left to "Tactically Tilt.” Since domestic equities is currently the number-one-ranked asset class, it is filled up to the maximum of 75% or until there is nothing left to allocate.

The following performance quilt shows a number of sample portfolios for the period beginning 12/31/2008 and running through 9/30/2020. Notice that over this 11+ year period, the cumulative performance of the DALI-based strategies ranged from +31.25% (DALI With Bogey) to +117.88% (DALI Tilt Moderate). Some strategies do better than others at different points in time and in different market environments, which is clear in the yearly breakdown. Because we have been in a strong bull market for US equities a majority of the last decade, it is the strategies that have allowed for the greatest overweight to that asset class that ultimately rise to the top in terms of cumulative performance.

While certain markets can lend themselves nicely to asset class rotation, oftentimes it is the sub-asset class decisions that help to generate significant alpha in the portfolio over time. For example, should you be overweighting technology or real estate? Treasuries or high yield bonds? Emerging or developed markets? 

The quilt below displays variations of the DALI Strategies discussed above but adds that additional layer of relative strength analysis to the sub-asset class level. To accomplish this, we have substituted DWA guided ETF Models' returns for each asset class instead of an index proxy. For instance, instead of buying the iShares Core S&P US Total Stock Market ETF ITOT for our US Equity exposure (as outlined in the quilt above); the quilt below assumes an investment in the First Trust Focus Five Model FTRUST5 for exposure to the asset class. As you can see, adding this layer of RS analysis into your portfolios offers tremendous value to each of the asset allocation strategies.

As treasury yields have stabilized over the last few months, nearly all fixed income groups still hold average group scores above the acceptable 3.00 threshold. However, this broad strength in the fixed income space has shown some shifting beneath the surface. During the COVID-19 sell-off, lower risk assets were in extremely high demand and treasury yields plummeted.

With the subsequent recovery in domestic equities, fixed income groups with closer ties to equity prices, such as Convertible Bonds and Corporate Bond-High Yield have done very well. On the other hand, fixed income groups tied to the US Treasury or Government have weakened. Although all these groups possess acceptable average group scores above 3.00, we can see that there are some glaring differences with regards to score direction.

The Convertible Bonds group has a strong score direction of 2.10 and is ranked second out of the 135 groups tracked on the Asset Class Group Scores page with an average group score of 4.96. Another area in the fixed income space that shown strong improvement is the Emerging Market Income group which has an average group score of 3.39 with a positive score direction of 1.40. We touched on this area a few weeks ago and its relationship to the US dollar which has fallen over the past few months. For a more in depth piece on a falling US Dollar and emerging market fixed income, click here. 

As we begin the historically volatile month of October in an election year, it is important to manage the risk associated with your client’s portfolios. One of the many reasons of having an allocation to fixed income is to reduce the volatility associated with the equity portions of your client’s portfolios, as the two asset classes have had a negative correlation during equity market drawdowns for the most part. In an environment where the areas hot in the fixed income space are highly correlated to equity performance, it is important to not drift too far away from the purpose of fixed income allocations. Of course these more equity correlated fixed income groups deserve to be a part of your portfolio as they have shown high relative and absolute strength, but be sure you are balancing that extra risk associated with them to the greater purpose of a fixed income sleeve.

Daily Option Ideas for October 1, 2020