Day Hagan Catastrophic Stop Update December 17, 2024
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The Catastrophic Stop model increased to 72.9% from 67.9% last week due to the sentiment composite shifting from bearish to neutral. The Internal Composite is bullish, and the External Composite is neutral.
Figure 1: The Catastrophic Stop model vs. the S&P 500 Total Return Index.
Figure 2: Sentiment has reversed from Excessive Optimism levels to Neutral. A drop below 40 followed by a reversal higher would be a good setup for the next rally.
We’re monitoring valuations from the perspective of “how much higher can it go?” While overvaluation conditions can persist, they’re a good indicator of risk, and risks are extended. Markets aren’t quite priced for perfection, but they're getting close.
Figure 3: High valuations = higher risk of disappointment.
In an X-post last week (@DayHagan_Invest), we wrote, “Let me start by saying we are not bearish. However, we spend a lot of time thinking about ‘what ifs.’ One of the questions we discussed at a recent Investment Committee meeting was, ‘What might the multiple contraction look like for the Info Tech sector if we run into a major bear market?’ The chart below shows that the P/E at price peaks averaged (median) 29.5x, with the subsequent troughs showing 13.1x. During the GFC and 2022 bear market, P/E multiples declined 16.4 and 10.3 points, respectively. Food for thought.”
Figure 4: Peak and Trough Valuations for the Information Technology Sector.
Figure 5: Consumer Staples Sector’s Peak and Trough Valuations. Even defensive areas of the market aren’t immune to multiple contraction. Although, with a P/E of 29.9x, it’s a bit of a stretch to say that this is a defensive sector.
Figure 6: The Utilities Sector’s Peak and Trough Valuations.
We also posted on December 11th that “Only 31.66% of S&P 500 companies outperformed the index through 12-10-2024. It's interesting how the 2023 and 2024 (so far) results look much like those of 1998 and 1999.” As of the 12-16-2024 update, only 29.46% are outperforming. That’s less than what was observed in 2023 in what was considered a very, very narrow market.
Figure 7: Only 29.46% of stocks are outperforming the S&P 500. This is not particularly healthy. But to be fair, 2023 and 2024 have shown strong index performance. (So did 1998 and 1999…)
There’s been a lot of discussion around the market’s breadth. Yes, there’s currently a divergence between the A/D line and price. However, the technical backdrop hasn’t broken down, so we presently view this condition as a minor warning sign. If we see more confirmation, we will be quick to reduce risk.
Figure 8: Divergences starting to appear.
Speaking of breadth, we posted last week, "Given the growing concerns around inflation, we note that 9 (was 10 last week) of 19 commodities are above their 200-day MAs, and 10 have rising 200-day MAs. Historically, this has supported higher commodity prices, which is inflationary (see stats box). However, contrast the levels seen at the beginning of the recent inflation surge (red highlight) vs. now (green). Clearly, not the same levels of pressure. If we start to see levels above 80 for both series, confirmed by the Inflation Timing model, we'll be in the ‘it's time to reduce risk’ camp.”
Figure 9: Commodity prices don’t reflect a new inflationary surge.
The Inflation Timing Model confirms this outlook with a “Neutral Inflation” outlook, though it has shifted from Moderate Disinflation. A move above 5 in the model would be concerning.
Figure 10: The Inflation Timing Model is now neutral. We’re monitoring this closely.
Bottom Line: Our conclusion from last week remains valid: “The Catastrophic Stop model continues to recommend a fully invested (matching your benchmark) position. There are signs of burgeoning inflationary pressures, but they are not yet considered a major impediment. Economic growth is OK, and earnings are holding up. As our indicators shift, we will adjust the portfolio accordingly, up, or down. At this point, our models' collective message is that the uptrend is intact.”
Our goal is to stay on the right side of the prevailing trend, introducing risk management when conditions deteriorate. 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 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.
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.
Sentiment – Market sentiment is the current attitude of investors overall regarding a company, a sector, or the financial market as a whole.
Price-to-earnings (P/E) ratio – A valuation metric that compares a company’s stock price to its earnings per share (EPS) to determine if a stock is expensive or cheap. It’s calculated by dividing the current stock price by the EPS, which is calculated by dividing the last 12 months of earnings by the weighted average shares outstanding.
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.
S&P 500 Consumer Staples – Comprises those companies included in the S&P 500 that are classified as members of the GICS® Consumer staples sector.
S&P 500 Utilities - Comprised of those companies included in the S&P 500 that are classified as members of the GICS utilities sector.
Breadth Thrust – A technical indicator which determines market momentum, signaling the start of a potential new bull market.
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