Day Hagan Research Update

DAY HAGAN RESEARCH UPDATE

INVESTORS REMAIN ON EDGE

SUMMARY

Approach this market from a tactical standpoint until we can break from a very broad and prolonged trading range.

WRITTEN BY

Neil Leeson

POSTED

June 29, 2016

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We don’t need indicators or models to tell us that investors are very nervous. Why else would there be such a negative reaction to a Brexit referendum that will take a few years, if ever, to implement? Maybe it was an excuse to sell overvalued equities that had rallied significantly since February lows. Two points I made in the June 17 blog—don’t own this market, rent it; and don’t have more on than you can sleep with—remain my best advice.

Putting historical indicators aside and getting back to basic market forces, recent action and reaction to Brexit in the bond, currency and equity markets suggest that the global economy is headed for a recession, led by the U.K. I am not arguing for a recession, but, as shown below, the Ned Davis Research Global Recession Probability Model has been arguing for a recession since late 2014. This model incorporates several indicators that have historically been correct in identifying economic weakness.


Global Recession Probability Model Chart

Unfortunately, historical models have little precedence for Brexit referendums, ZIRP policies, billions in negative yielding debt, bond buying programs and political stagnation. How do you model that? Folks, we are flying without instruments! One component of the recession model is shown below. This chart shows the global manufacturing PMI, which is just above the all-important fifty level. But the level may not be as important as the trend in the top (raw index) and bottom clips (year-over-year point change): FLAT. It has gone virtually nowhere for the past five years. This is a great example of how historical indicators/measures have changed. While this may be one example, there are several other instances of economic indicators that have flatlined. Maybe this is temporary, maybe not. But until global growth accelerates, equity gains and higher yields will remain range-bound.


JPMorgan Global Manufacturing PMI Chart

BROAD TRADING RANGE

Technical/price-based indicators are mixed when you look across different timeframes. Short-term measures suggest the markets are oversold, while long-term measures still support a bullish case. This year we have rarely seen the two align. Participation improves one week and disintegrates the next. Risk-on for a few days and risk-off for a few. All of this tells me that we are in a very broad trading range in the U.S. capped by new highs (2,100) and lows (1,850) in the S&P 500 that were made earlier this year.

In such an environment, I suggest having a tactical allocation larger than a core allocation. If you are unable to implement shorter-term trades, your cash position should be higher than normal. At some point a longer-term trend will develop, but for now, the markets will remain volatile and continue to trade on news events.

For tactical decisions, the Griffin Hagan ETF Trading Model is a good place to start. When this model is bullish (current reading), your bias should be to the bullish side (buying the dips), and when the model is bearish, your bias should be to the bearish side (selling the rallies).


ETF Trading Model vs. S&P 500 Index ETF (SPY)

FINDING ETFS TO CONSIDER

If you are on the bullish side and buying the dips, you should avoid selling short overbought areas. You may want to take money off the table in overbought areas, but not shorting when the overall ETF Trading Model is positive. Reserve shortselling for overbought areas when the model turns negative. Your best tactical long opportunities (buying dips) may be areas that are oversold on a short-term basis.

As shown below in the second clip, IBB, the biotech ETF, is reversing from oversold conditions (one of many examples).


Buying Pressure: iShares Nasdaq Biotechnology (IBB)

Griffin Hagan Research has developed a broad array of ETF indicators to evaluate ETF price and momentum over different timeframes. As outlined, in the current environment, focus on the shorter-term ETF Model and shorter-term ETF indicators. Once we break from this trading range, let the ETF Investment Model and longer-term ETF indicators be your guide.


ETF Investment Model vs. S&P 500 Index

Have a wonderful week,

Neil Leeson
Day Hagan Asset Management Investment Committee

— Written 06-28-2016

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