Day Hagan Catastrophic Stop Update August 27, 2024
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Catastrophic Stop Update
The Catastrophic Stop model held steady at 48.6%. The Internal and External Composites are neutral.
Figure 1: The Catastrophic Stop model moved lower but is still in positive territory.
Below are two good examples of indicators within the model that are poised to reverse back to buy signals.
Figure 2: Short-term Trend indicators are hovering around neutral levels. A decisive move in either direction should quickly be reflected in the overall model.
The same holds true for our measures of credit spreads. For example, high-yield OAS could quickly reverse to bullish levels. Even though the indicator has generated a sell signal, it wouldn’t take much to reverse it.
Figure 3: The High-yield OAS moving averages have ticked higher but are still at historically low levels. Indicates that the financial markets are behaving relatively normally. A spike higher would be concerning.
Figure 4: Daily OAS for High Yield, IG Corporates, Mortgage-Backed Securities, and U.S. Agencies have moved lower following the July 16-August 5 equity market decline. This is constructive for equities.
There was a nice short-term momentum buy signal generated on 8-15-2024. However, given the indicator's current state, it will move to a sell signal when it reverses back below the top Standard Deviation bracket. This short-term indicator is designed to be a “first alert” for potential market weakness. We’re monitoring this closely.
Figure 5: Short-term momentum is currently supportive, but now at levels where a reversal would quickly shift the indicator to a sell signal.
Figure 6: Economic indicators calling U.S. activity continue to miss expectations. This needs to be reversed for a significant new leg higher. In Powell’s remarks at Jackson Hole, he noted that the labor market had clearly slowed, and the current level of the policy rate provided ample room to respond to greater-than-expected labor market weakness if needed. This seemed to confirm that rate cuts are on the table, with the first likely happening in September. Last week, the 2-year Treasury yield declined by 13 bps (to 3.92%), while the 10-year Treasury yield declined by eight bps to 3.80%.
With that in mind, it's time to pull this chart out again. Recall that when reviewing the last 17 "First Rate Cuts" through the lens of earnings growth and multiple valuations, we noted that multiples have tended to expand (green line) while earnings growth was mixed, if not subdued (red line). The net result, historically, was an uptrend in stocks (blue line). But, with multiples already at the high end of the historical range, multiple expansion may not be able to save the day. It's up to earnings. Notice that the S&P 500 returns are very negative for 2001 and 2007. The point is that if the Fed is cutting into a recession, the cuts may not be enough to provide a useful “Powell Put.”
Figure 7: All first rate cuts since 1954. The “average” suggests a positive tilt. However, it’s not a perfect indicator.
Figure 8: The two “first rate cuts” before recessions showed EPS getting crushed but P/Es expanding strongly. Again, we don’t see this type of scenario currently in play, or likely. Nonetheless, if our economic indicators shift to a radically negative stance, we will adjust accordingly.
Figure 9: The Earnings Model is neutral. Historically, earnings have grown when the model has been in this zone. Note: The model includes diverse measures of Industrial Production, yield curves, PMIs, credit spreads, earnings momentum, and estimate revisions.
Figure 10: Last week’s Update mentioned that a 10:1 Up-Day occurred on 8-8-2024. We posited that a confirming 10:1 Up-Day would be bullish. A second 10:1 Up Day reading was generated on 8-23-2024.
Bottom Line: The quantitative, unemotional outlook confirms that economic growth is decelerating but still positive overall. Inflation pressures continue to diminish. 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.
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.
Purchasing Managers Index (PMIs) – Is an indicator of the prevailing direction of economic trends in the manufacturing and service sectors. The indicator is compled and released monthly by the Institute for Supply Management (ISM).
Option-Adjusted Spread (OAS) – Is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is then adjusted to take into account an embedded option.
Powell Put – Is the theory that if equity markets continue to slide, the Federal Open Market Committee (FOMC) will be forced to step in with monetary aid.
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