Day Hagan Catastrophic Stop Update July 23, 2024
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Catastrophic Stop Update
The Catastrophic Stop model increased to 82.9% from 77.9% last week. The Internal and External composites are bullish.
Figure 1: The Catastrophic Stop model remains positive.
The Catastrophic Stop model’s recent increase resulted from the Sentiment Composite moving from excessive optimism to neutral. Last week, we discussed overly optimistic sentiment and the potential associated headwinds. Interestingly, equity indexes subsequently retreated, with the S&P 500 down -1.9% last week (the largest loss since the April selloff), the NASDAQ down -3.6%, and the MSCI All-Country World Index down -2.1%. The Mag 7 was down -5.3% (it was down 7.8% in April).
The lone winning equity category was smaller-cap stocks, with the Russell 2000 up 1.7% last week. Also of interest, as small-cap stocks gained, U.S. High-Yield OAS (option-adjusted credit spreads) tightened by 4 bps, while U.S. Investment-Grade Corporate OAS widened 2 bps. Lastly, the dollar index increased by 0.3%, which generally supported smaller caps. However, the small-cap run was led by the “Potential Squeeze,” “Crowded Shorts,” “Meme Stock,” and “Credit Laggard” themes, while “Quality” was one of the worst-performing themes. This is similar action to what we saw in April.
Figure 2: Sentiment back in the neutral zone.
Worth repeating from last week: Looking at the last 17 "First Rate Cuts" through the lens of earnings growth and multiple valuations, we note 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 expansions may not be able to save the day. It's up to earnings. (Note: The S&P 500 Forward P/E is 21.4x vs. the 10-year average of 17.9x.)
Figure 3: Multiple expansion has historically driven market gains after First Rate Cuts, increasing an average of 28.15%. Conversely, earnings have declined an average of -9.32% in the year following a First Rate Cut.
Also, as described last week, earnings growth needs to come through. Below are the updated expectations.
Figure 4: Earnings growth expectations are elevated for 2024 and 2025. This requires the U.S. and global economy to continue to grow.
Looking over our sector models, the most significant change has occurred in the Consumer Discretionary model, which increased from 45.8% to 62.5% since the July 1 rebalance. The overall model has improved and now resides in positive territory. The increase is due to recent positive short-term momentum and an expanding number of new highs, indicating broadening upside participation. Relative valuations are favorable, and consumer credit conditions remain supportive. On the negative side, higher interest rates and the resulting slowdown in discretionary consumer spending are headwinds. Even McDonald’s (MCD) recently missed estimates as consumers became more cost-conscious. Amazon’s (AMZN) view on consumer spending is also somewhat cautious, though Prime Day saw an 11% y/y increase. It notes that customers are trading down on price and seeking out deals. Consumer spending appears to be weaker in Europe than in the U.S. Amazon pointed to some softness in the global economic environment, particularly in Europe, with consumers being more restrained in spending. Consumer spending is the foundation for economic growth, and some signs of improvement exist.
Figure 5: Short-term price momentum has improved. Goldman Sachs notes that last week, according to their prime book, all sectors were net sold except Consumer Discretionary and Communication Services.
Figure 6: Measures of discretionary consumer spending ticked higher in June
Figure 7: The most recent retail sales report was relatively good, ex-autos. High-ticket items are under pressure. We expect that a rate cut will initially unleash some pent-up demand.
A little macro: The Inflation Timing Model increased slightly with the final June update. So far, inflation is heading in the right direction (lower), but when the quantitative, unemotional models and indicators shift, we notice.
Figure 8: Inflation pressures slightly increasing due to better economic activity, banks becoming more willing to lend, and rates stabilizing. We’re monitoring closely, as our current outlook remains in the “Neutral Inflation Pressures” camp. We’ll keep you posted should inflationary pressures accelerate (which we don’t currently expect).
Lastly, there are several Treasury upcoming auctions to watch (2s, 5s, and 7s) for signs of demand, and the Q2 2024 GDP advance estimate will be released on the 25th. Expectations are for +2.0%, up from 1.4% in Q1(annualized quarterly change). As long as economic growth continues, earnings can come through.
Figure 9: U.S. Economic growth expected to remain near-trend.
Bottom Line: 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 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 Consumer Discretionary – Comprises those companies included in the S&P 500 that are classified as members of the GICS consumer discretionary sector.
Sentiment – Market sentiment is the current attitude of investors overall regarding a company, a sector, or the financial market as a whole.
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