Day Hagan Strategy Update




General commentary regarding the after effects of the Brexit vote, the global financial markets, and an update regarding the Day Hagan Tactical ETF Strategy.


Donald L. Hagan, CFA


August 8, 2016


What do the Brexit vote’s aftermath, a bear market in oil prices, a stronger U.S. dollar (which negatively impacts U.S. multinational profits), a second quarter U.S. real GDP release showing economic growth at less than half of what was expected, weak economic reports in the EU region and Asia, disappointing quantitative easing announcements from the Bank of Japan and the Bank of England, an ever-widening array of sovereign bonds with negative interest rates, and the FOMC’s paralysis have in common?

None of them caused the markets to decline in July. (Source: Barron’s) In fact, all of the major developed markets in the Asia/Pacific, Europe and North American regions were up.

Some are ascribing the gains to TINA. What is TINA? TINA = “There is no alternative.” In other words, investors looking for safety can’t earn a decent return, so they are being forced into risk assets, which generally mean stocks. According to this dictum, there simply isn’t an alternative to owning stocks if an investor seeks a livable return.

From our perspective, when one buys stocks, one is taking on risk. We will only take on risk when the rewards will compensate us for the risks we are taking. Buying stocks because, well, there isn’t anything else to buy is quite simply folly. Our goal is to balance risk and reward, which has led us to the neutral-to-mildly-bullish equity investment position we’ve maintained for most of the past year. Given global equity markets’ wide-ranging movement and the fact that the S&P 500 is up just ~3.99% total return for the one year through the second quarter, our models’ dictates to minimize risk relative to potential returns were appropriate – even under the scrutiny of 20/20 hindsight.

Many of the concerns we addressed in last month’s letter remain intact:

1) Global economic growth prospects have not improved. Total OECD real GDP expectations for 2016 are for 1.8% growth, down from 2.4% in 2015. And that’s a result that has been boosted by massive QE and unprecedentedly low interest rates.

2) U.S. earnings revisions are not moving higher. FactSet reports that overall earnings estimates indicate that 2016 earnings are currently forecast to be lower than 2015. All hopes are on an acceleration in earnings in Q4 2016.

3) China’s outlook has not improved. China’s industrial production, real GDP growth rates, retail sales and fixed asset investment growth continue to hit new lows. Granted, the numbers are still better than everywhere but India (in most cases), but China is no longer the growth powerhouse of just a few short years ago. Even China added $1 trillion in investment during Q1, with no meaningful results. China’s equity markets, at the end of July, were down -15.8% in local currency.

4) Europe’s situation has not improved. Manufacturing data continues to disappoint and the European banking system is under extreme duress in the face of negative interest rates. In fact, in Italy, the financial regulators are actually in the midst of enacting a bank bail-out of Italy’s largest sovereign bank. Other major EU banks are seeing their share prices decimated.

5) Oil has not stabilized. Oil entered bear market territory. This is creating strains on loan availability, banks’ balance sheets, oil companies and countries.

6) QE is proving less and less effective. Clearly, the short-term effects of QE remain intact based on the magnitude of short-term market moves resulting from the flurry of “newly released proclamations and promises” by central bankers. However, we are noting that longer-term effects diminish quickly. Our view is that QE measures don’t change overall demand. They simply bring forward demand that was already going to occur. This leaves a hole once the time is reached when the pulled-forward demand would have happened. This is why central banks are stuck in their own version of Dante’s Inferno (my best guess is somewhere within the Eighth Circle). They can’t create new demand; they can only change the timing. At some point, they will have brought forward all of the demand they could and what will be left is the true economic picture.

With regard to our current portfolio holdings (as of 8/7/2016), we remain overweight U.S. equities versus international equities and are neutral on value companies versus growth. We are maintaining a low fixed income duration. We continue to have exposure to U.S. Large Capitalization Growth companies, but have been increasing our exposure to Small Capitalization Value over the past two months as our models for Small Cap stocks have shown improvement. Our international exposure continues to be primarily focused on Emerging Markets and Canada. However, we did initiate a small position in the Hedged Japan ETF, as we expect some near-term improvements in response to recent QE initiatives.

Like last month, our models’ message is that this isn’t the time to be overly bearish (negative), nor is it the time to be overly aggressive. A more neutral/mildly bullish stance is currently warranted. We will be looking for our models and the weight of the evidence to turn more positive before committing additional capital to equities. At this point, the competing number of bullish and bearish indicators illustrate that markets remain vulnerable and are likely to continue to meander until economic growth can find a more solid foothold.

If you have any questions or comments, please feel free to call anytime.


Donald L. Hagan, CFA

— Written 08-08-2016

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