Day Hagan Research Update




The shift in focus from monetary to fiscal policy continues to drive investor sentiment.


Neil Leeson


February 24, 2017


When the Federal Reserve Chairman Janet Yellen, was before Congress for the semiannual monetary policy report last week, equity markets had an unexpected reaction: strength. This occurred despite the generally hawkish tones and accompanying possibility of higher interest rates sooner rather than later. Subsequently, when the FOMC meeting minutes from the Jan. 31-Feb. 1 were released this past Wednesday, there was little market reaction to the news. So, it seems that the market (investors) are okay with higher interest rates. Apparently, investors are betting that the drag of higher interest rates will be offset by the economic prosperity brought about by potentially stimulative fiscal policy. It is obvious that Fed Chairman Yellen is aware of the extreme optimism that President Trump has bestowed upon the markets. In fact, based on her testimony, she stands ready to adjust monetary policy accordingly.

Therefore, I believe the newest financial market axiom should shift from "Don't Fight the Fed" to "Don't Fight the Trump." (Soon to be trademarked.)

As I wrote last week, bull markets don't typically die of hold age—there must be a catalyst to expose the markets to more than minimal corrections (less than 7-10%) brought on by extreme sentiment, overbought conditions or valuation extremes. Since the Great Recession—which officially lasted from December 2007 to June 2009—began with the bursting of an 8 trillion-dollar housing bubble, the Federal Reserve has instituted accommodative monetary policies that have supported the economy and the equity markets. It was always my belief, shared by many others, that the Fed would do whatever it could to keep the economy (and markets) afloat.  I now think this responsibility has shifted from the Fed to the Trump administration.

And just like you shouldn't have bet against the central bank for the past eight years, I don't think you want to bet against Trump going forward. I don't have any hard evidence for this opinion, but based on his actions thus far, I am under the impression that the President will do whatever it takes to keep the economy (and markets) afloat. I have no doubt that several areas of the economy and markets will do better than others, but overall, the "Trump Trade" may be in effect for the next four years.

Our approach at Day Hagan has always been a weight-of-the-evidence approach and giving the trend the biggest benefit of the doubt. It is hard to argue with the trend strength of global and domestic equity markets, while some sectors and country indexes are doing substantially better than others, in aggregate we are in the presence of a global bull move in equities. However, as we have noted for the past several months, there are indicators flashing caution signs that should temper any near-term bullish attitude; valuation, sentiment, and overbought momentum come to mind. But until we see a change in investor demand for equities, which will in turn shift trend indicators from bullish to bearish, we remain "cautious bulls" longer-term.

The chart below is one that I highlighted last week. Since then, it has actually improved as we continue to see more demand (buyers) than supply (sellers). We think that a significant reversal in trend in this indicator/chart would indicate that buying has become exhausted. But for now, this indicator is solidly bullish. Nonetheless, we continue to view any pullback in equities as a buying opportunity—baring a significant event that may have a longer-term impact on economic growth and the economy.


While we remain respectively of the trend, we do see some type of pullback in the coming months as a significant probability. The cause may be due to buyer exhaustion or the end of retirement funding prior to the April tax filing deadline, or any number of other reasons. From a seasonality standpoint, however, March through May have been typically strong months for domestic equities. This further supports our current "buy the dip" thought process.

While we are currently cautiously bullish longer-term, based on near-term excesses, we are overweight cash to help cushion near-term shocks to the market. We would look to increase our equity allocation at different intervals of support. For example, if the market were to decline 3%, 5% or 7%. Beyond a 7% drawdown we would have to put heavier weight on external indicators that gauge economic and earnings growth to make sure there wasn't another major financial dislocation occurring that could lead to global financial duress.

Our current near-term cautious allocation and cash position should allow us to weather any short-term decline and take advantage of lower prices in those securities that have the most potential into year end.

Have a wonderful week,

Neil Leeson
Day Hagan Investment Committee Consultant
Day Hagan Asset Management

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