Day Hagan Catastrophic Stop Update August 5, 2024
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Catastrophic Stop Update
Given the market's gyrations today and Friday, we’re sending out this Update early. We’ll provide interim updates should conditions warrant.
The Catastrophic Stop model declined to 60.7% from 82.9% last week (based on Friday’s close). The Internal Composite (price-related indicators) is bullish, and the External Composite (operating environment for equities) is now neutral.
Figure 1: The Catastrophic Stop model moved lower but is still in positive territory.
The lower model reading is the result of the Breadth Factor turning negative, the Baltic Dry Index Factor indicating decelerating global economic activity, and the widening of high-yield OAS (option-adjusted spreads).
Figure 2: Breadth back to levels seen at the previous market lows. This is not unexpected, given the quick reversal in small-cap relative performance. This indicator tends to move rapidly.
Figure 3 Economic activity has declined slightly, but overall, real GDP growth is still positive. The Baltic Dry Index Factor has moved moderately lower (chart below).
About last week's employment report: The Sahm rule was not triggered, using unrounded data.
The number of unemployed increased by 352k, with 314k being job losers.
But 79% of the job losers were on temporary layoff.
461k people were out of work due to weather (more than 10x the average monthly July number).
250k were out of work due to other reasons, including auto shutdowns and factory retooling.
The unemployment rate for college-educated workers declined.
Our bottom line is "not great, but not as bad as investors seem to be factoring in."
We note that today's U.S.-related Services PMIs are encouraging, with the ISM Services PMI at 51.4 versus expectations of 51.1 and last month’s reading of 48.8. In fact, the Spanish, Italian, French, and German Services PMIs all registered readings above 50 (released overnight).
Figure 3: Economic activity has declined slightly, but overall, real GDP growth is still positive. The Baltic Dry Index Factor has moved moderately lower (chart above).
We note that today's U.S.-related Services PMIs are encouraging, with the ISM Services PMI at 51.4 versus expectations of 51.1 and last month’s reading of 48.8. In fact, the Spanish, Italian, French, and German Services PMIs all registered readings above 50 (released overnight).
Figure 4: Credit spreads have widened alongside the market’s weakness. However, spreads are still tight relative to history. Note the moves seen in 2020 and 2022 for reference.
At the beginning of the month, we rebalanced the portfolio’s sector allocations to lower its beta. We reduced exposure to information technology, financials, and health care and increased exposure to staples, utilities, and industrials. For details, please see our Smart Sector updates here: https://dayhagan.com/research.
Figure 5: The Information Technology Internal Composite is neutral. If breadth, momentum, and/or OBOS indicators reverse, causing the model to improve, we will react accordingly. Conversely, if the model moves lower, we’ll continue to reduce exposure.
Figure 6: We’ve featured this indicator before. It represents what we’re seeing from an OBOS perspective for the tech sector. A reversal from the oversold lows would provide short-term support for adding exposure.
There are several indicators that we monitor to inform us of the state of any selloff. We look for intense oversold conditions, excessively pessimistic sentiment, and a momentum reversal to identify high-probability market lows (encapsulated in our S&P 500 short-term buy model used in the Catastrophic Stop strategy). Below are some of the charts that we consistently review for indications that selling is likely to dissipate.
Figure 7: The most receFigure 7: Short-term sentiment composite is now in the excessive pessimism zone. Likely to be lower after today. If the sell-off is indeed overdone, this indicator should start showing improvement soon (i.e., a return toward optimism).
Figure 8: If today's levels hold, the sentiment of non-professional retail traders will also move into the excessive pessimism zone, confirming the previous chart.
Figure 9: TRIN indicators (comparing upside volume to downside volume over various time frames) show that the selling has been significant enough to set these up for buy signals. We require a reversal back through the upper band to signal that selling is decelerating and/or reversing.
Figure 10: The McClellan Summation Index provides long-term buy signals when the oscillator falls below -3450 (or indicates a breadth thrust with a move above 0). It hasn’t triggered either signal since the October 12, 2022, bottom. We use several similar indicators to identify major lows. So far, none have declined enough to do so.
Figure 11: Like the McClellan Summation Oscillator above, the 10-week A/D Diffusion Index shows that advancing issues and declining issues over the past 10 weeks have been relatively matched. A move below 38 would provide bullish support (i.e., intense oversold conditions).
Figure 12: From a simplicity perspective, looking at only 200-day moving averages, when the number of stocks above their respective 200-day moving averages falls below 42% and then rises back above that level, it has provided bullish support.
Figure 13: Of course, if a couple of our favorite breadth thrust indicators generate buy signals, it would be bullish and confirm that the uptrend is ready to start a new leg higher. Below is the deGraaf Thrust Indicator.
Figure 14: The Zweig Thrust Indicator uses advances and declines to determine major oversold conditions. A drop below 40 and then a reversal above that level would be bullish.
Figure 15: Bottom Line: For major lows, we want to see reversals from levels denoting intense selling, excessive pessimism, and short-term momentum measures flip from “sell” to “buy.” Historically, this set of conditions has provided high-probability buy opportunities. Below is an example of one of our preferred short-term momentum reversal indicators.
In recent updates, we’ve shown the importance of economic growth relative to stock trends. Below is the table illustrating financial asset performance during different combinations of economic growth and inflation. As you can see, as long as economic growth is stable or rising, equities tend to appreciate, regardless of the inflation backdrop. However, weak economic growth is negative for U.S. equities, whether inflation is rising, stable, or falling.
Figure 17: The Economic Timing Model continues to reside in the Moderate Growth zone.
Figure 18: The Inflation Timing Model is in the Moderate Disinflation zone but heading toward Neutral. We believe inflation is not likely to spike higher without an exogenous event.
Figure 19: Rate cuts are coming.
Figure 20: The 6-month Implied Forward Treasury Bill rate implies 110 bps of potential easing.
Bottom Line: We are monitoring economic growth closely, as that is the driving force behind the recent decline (among myriad other factors). The quantitative, unemotional outlook confirms that economic growth is decelerating but still positive overall. Inflation pressures continue to diminish. The situation is fluid, to say the least. As our indicators shift, we will adjust the portfolio accordingly, up or down. Our goal is to stay on the right side of the prevailing trend, introducing risk management when conditions deteriorate. Currently, the uptrend remains intact. As has been the case for all of 2024, the broader-based composite models calling U.S. economic growth, international economic growth, inflation trends, liquidity, and equity demand remain constructive. The Catastrophic Stop model is positive, and we are aligned with the message. If our models shift to bearish levels, we will raise cash.
This strategy utilizes measures of price, valuation, economic trends, monetary liquidity, and market sentiment to make objective, unemotional, rational decisions about how much capital to place at risk and where to place that capital.
If you would like to discuss any of the above or our approach to investing in more detail, please don’t hesitate to schedule a call or webinar. Please call Tyler Hagan at 941-330-1702 to arrange a convenient time.
I hope you have a wonderful week,
Sincerely,
Donald L. Hagan, CFA
Chief Investment Strategist, Partner, Co-Founder
Charts with models and return information use indices for performance testing to extend the model histories, and they should be considered hypothetical. Charts courtesy Ned Davis Research (NDR). © Copyright 2024 NDR, Inc. Further distribution is prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers, refer to www.ndr.com/vendorinfo.
Disclosures
S&P 500 Total Return Index – An unmanaged composite of 500 large capitalization companies. This index is widely used by professional investors as a performance benchmark for large-cap stocks. This index assumes reinvestment of dividends.
S&P 500 Information Technology – Comprised of those companies included in the S&P 500 that are classified as members of the GICS information technology sector.
Sentiment – Market sentiment is the current attitude of investors overall regarding a company, a sector, or the financial market as a whole.
Baltic Dry Index Factor – Is a shipping and trade index created by the London-based Baltic Exchange. It measures changes in the cost of transporting various raw materials, such as coal and steel. The Baltic Dry Index is a composite of four sub-indices that measure different sizes of dry bulk carriers or merchant ships: Capesize, Panamax, Supramax, and Handysize.
Option Adjusted Spread (OAS) - The measurement of the spread of a fixed-income security rate and the risk-free rate of return (the theoretical rate of return of an investment with zero risk), which is then adjusted to take into account an embedded option.
ISM Service PMI – An index that measures the economic condition and performance of service-based companies. It is now called the Services Purchasing Managers’ Index (PMI). This index is based on surveys sent to purchasing and supply companies of more than 400 services firms.
Credit spread – The difference between two debt securities with different credit ratings but similar maturities. It is a common way to measure how much of a premium an investor might receive for taking on more risk.
Sahm Rule – Signals the onset of a recession when the three-month average unemployment rate rises 0.5 percentage points or more above its lowest point in the past year.
OBOS Indicators – Overbought/Oversold (OBOS) index relates the difference between today’s closing price and the period’s low closing price with the trade margin of the given period.
McClellan Summation Index – A popular technical analysis took for visualizing and understanding market breadth. It helps identify overall market direction and momentum.
deGraaf Thrust Indicator – Measures the percent of stocks making new 20-day highs. A bullish signal is given when 55% or more of S&P 500 names make new 20-day highs.
Disclosure: The data and analysis contained herein are provided "as is" and without warranty of any kind, either express or implied. Day Hagan Asset Management, 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. Day Hagan Asset Management accounts that Day Hagan Asset Management 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. Day Hagan Asset Management uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. The performance of Day Hagan Asset Management’s past recommendations and model results is 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.
There is no guarantee that any investment strategy will achieve its objectives, generate dividends, or avoid losses.
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