Day Hagan Research Update

DAY HAGAN RESEARCH UPDATE

WEIGHT OF THE EVIDENCE STILL SUPPORTS THE BULLS

SUMMARY

Upside earnings surprises continue to support the domestic markets.

WRITTEN BY

Neil Leeson

POSTED

May 8, 2017

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Our weekly review of indicators and models used for evaluating our current portfolio holdings, global equity markets and economic activity remain supportive of the bullish case. We have written in the past about expectations versus reality, noting that our disciplined approach mandates that we side with reality rather than expectations. Early in the year, expectations were high that S&P 500 company earnings would exceed lofty expectations, which would in turn justify higher equity prices.

As shown below, nearly 80% of S&P 500 companies that have reported thus far have surprised to the upside based on aggregate analyst estimates. This "reality" is a positive sign from the earnings front.



While current earnings beats are encouraging, the median price-to-earnings measure has only improved slightly because prices continue to move higher, suggesting that prices continue to run well ahead of earnings.



As shown on the next chart, many valuation measures remain in overvalued terrritory and are considered a slightly negative indicator in our weight-of-the-evidence approach. Nonetheless, an improved earnings environment is a positive development for equities.

In addition to stock valuations, S&P 500 dividend yields relative to 10-year Treasury yields remain a tailwind for equities. Even though bond yields have increased somewhat over the past few weeks, they still remain far too low to compete against stock yields. Investors will go where their money is treated best, and for now, that remains in the equity markets.



From a trend perspective, not much has changed this year. The majority of global markets remain above their short-, intermediate- (next chart), and longer-term moving averages.



Several global index ETFs, including the VGK (Vanguard FTSE Europe ETF), have advance/decline lines making new highs on a daily basis (chart below, third clip). Europe remains attractive from a trend, valuation and monetary policy standpoint.



Strong global market trends coupled with favorable economic and monetary indicators have provided investors with an extremely optimistic outlook on the markets. Not only are U.S. investors optimistic on equity markets, so are international investors.

The DSI Global Sentiment Composite has reversed significantly over the past few weeks and is once again in the optimistic zone. Such elevated optimism suggests that investors are once again reaching the "greed" stage of investing, and that the "theater is becoming a little crowded." Sentiment extremes tend not to bother us when they are rising or falling; it is the reversal from optimistic and pessimistic extremes that concern us. Typically, we like to "go with the flow" of sentiment and shift to a more cautious stance when optimism starts to fade. This has become a very important indicator to watch in regards to our allocation. At this juncture, we are not adding further equity exposure. However, we would look to add once sentiment becomes less optimistic.

In sum, earnings growth has recently been exceeding expectations—which is a positive for domestic equities. On a relative valuation perspective (versus bonds), stocks continue to benefit from significant tailwinds. Breadth and trend measures are bullish both for domestic and international equities. Our only concern at this point are sentiment measures that suggest investors here and abroad are extremely optimistic on equities, indicating that the trade may be somewhat crowded. Nonetheless, we will continue to follow the crowd at this time, but will not look to add until some of the optimism wanes. Our weight-of-the-evidence approach has kept us in harmony with the overall bullish trends we are seeing globally.

Have a wonderful week,

Neil Leeson
Day Hagan Investment Committee Consultant
Day Hagan Asset Management

Disclosure: The data and analysis contained herein are provided "as is" and without warranty of any kind, either expressed or implied. Day Hagan Asset Management (DHAM), any of its affiliates or employees, or any third party data provider, shall not have any liability for any loss sustained by anyone who has relied on the information contained in any Day Hagan Asset Management literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. DHAM, accounts that DHAM or its affiliated companies manage, or their respective shareholders, directors, officers and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. DHAM uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. When evaluating the results of prior DHAM recommendations or DHAM performance rankings, one should also consider that DHAM may modify the methods it uses to evaluate investment opportunities from time to time, that model results do not impute or show the compounded adverse effect of transactions costs or management fees or reflect actual investment results, that some model results do not reflect actual historical recommendations, and that investment models are necessarily constructed with the benefit of hindsight. For this and for many other reasons, the performance of DHAM's past recommendations and model results are not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries, nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.

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