Day Hagan Research Update

DAY HAGAN STRATEGY UPDATE

DAY HAGAN TACTICAL DIVIDEND STRATEGY UPDATE

MAY 2017

SUMMARY

Day Hagan Monthly Strategy Update for the Day Hagan Tactical Dividend Strategy, May 2017.

POSTED

May 5, 2017

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Year to date through April, the Day Hagan Tactical Dividend Strategy (DHTD) has returned +0.58% gross of fees and +0.39% net of fees. Although year-to-date performance is lagging behind the S&P 500 and to a lesser extent the Russell 1000 Value index (given value's underperformance more broadly), the positive returns have been generated even as the strategy maintained a highly defensive stance. The cautious posturing is a result of our work signaling meaningful overvaluation, nearly 27%, within our eligible universe of industries and names. We note that the so-called "FANG" (Facebook, Amazon, Netflix, Google/Alphabet) stocks continue to drive S&P 500 index gains year to date in a very narrow market. In fact, these technology growth plays are not the only pricey names—many recognized value sectors are becoming increasingly expensive on a fundamental basis as well.

During the month, our retail holdings (represented by the Discount Stores industry grouping) stabilized and were up about 2.5% after having a difficult start to the year. Costco (COST) and Wal-Mart (WMT) were top April performers in the portfolio overall. Discount stores and Asset Management were our two best performing industries during the month. For the year to date, technology, as represented by our IT Services industry, is leading performance while Energy has lagged. IT Services year to date (~+10%) has been led by the payment processors, Mastercard (MA) and Visa (V). Subsequent to April month end, both companies reported attractive quarters, beating consensus estimates and showing impressive transactional volume growth.

We believe our Energy names are at an inflection point, with a meaningful jump in free cash flow already starting to show. As evidence of this, the 2017 consensus estimate on Exxon Mobil (XOM) free cash flow per share is $2.94 versus $0.66 in 2016, with similar increases playing out across all four of our energy names. All of our energy holdings have meaningful balance sheet cash, relatively conservative capital structures in terms of debt loads (between 19%-31% Long-term debt to Total Capital across the names) and we believe they will also generate consequential free cash flow over the next few years, even understanding the macro backdrop can create some uncertainty. In addition, a focus on streamlining the expense side without mortgaging the future away is already paying off on the bottom line for these energy names.

It is worth noting that our modeling starts from the perspective of a company's lengthy history of uncut dividends while screening for healthy fundamentals to ensure continued payment of the dividend without issue. This is the basis for developing precise buy and sell thresholds, using historical absolute and relative data, for an eligible industry and its underlying names. Looking at our Asset Managers as an example, the industry grouping's current yield overall is 3.4% which is, based on our objective process, in a clear buy range. It is also 50% above its historical relative (relative to our overall eligible universe at any given time) yield, another strong buy signal. There are other checks and balances in the modeling as well. From this point, although a given industry/name has already passed through a large number of fundamental screens to be eligible at all, we subsequently do an additional deep dive, our final fundamental overlay to the modeling process. This overlay is to establish that the company being considered as part of the invested universe has characteristics that include, but are not limited to a healthy balance sheet, with meaningful liquidity and a manageable capital structure, a history and future of significant free cash flow generation, and shareholder-friendly management.

For any of the portfolio's owned industries and underlying equities meeting our rigorous yield-based modeling and fundamental criteria, our objective is to buy at or near trough valuations. As a result, we believe that while we don't at present have enough names meeting our criteria to be fully invested, what we do currently own has highly attractive risk-return opportunity as we measure it. Our defensive portfolio positioning, a byproduct of the strict and objective investment process referenced above, includes a meaningful cash position at present. Historically when DHTD has had less than 80% equity exposure, the S&P 500 shows negative returns. However, our goal is to be fully invested, process permitting, and we continue to have multiple industries across sectors on a buy watch list. For now, we continue to hold six industries (with healthy cross-sector representation) and 25 names. The number of equities represents the low end of our historical range.

The investment philosophy and underlying foundation has not changed since the strategy's inception in 2002. The result is attractive (but below index) upside capture (~70%+) and very conservative downside capture (~50%). DHTD since inception has returned +9.57%* gross (8.45%* net) on an annualized basis (with beta of 0.6) versus the S&P 500 Total Return at +7.13% and the Russell 1000 Value at +7.30%. All numbers are total return.

We continue to have high conviction and confidence around our invested portfolio both in terms of return potential and downside protection. As always, our discipline remains intact and we welcome questions or comments any time.

Sincerely,

  • Robert Herman
  • Donald L. Hagan, CFA
  • Jeffrey Palmer
  • Arthur S. Day

Note: The S&P 500 Index is based on the market capitalizations of 500 large U.S. companies having common stock listed on the NYSE or NASDAQ. The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. Indexes are unmanaged, fully invested, and cannot be invested in directly.

Disclosure: *Note that individual's percentage gains relative to those mentioned in this report may differ slightly due to portfolio size and other factors. 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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