Day Hagan Catastrophic Stop Update July 30, 2024
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Catastrophic Stop Update
The Catastrophic Stop model held steady at 82.9%, the same level as last week. The majority of Internal and External indicators remain bullish.
Figure 1: The Catastrophic Stop model remains in positive territory.
As we’ve emphasized in past Updates, the trajectory of economic growth and the associated earnings growth are pivotal to the sustained expansion of the equity markets. With that in mind, the Q2 advance estimate for GDP growth came in at a solid 2.8% annualized quarterly change (chart below), better than the 2.0% forecast and the 1.4% achieved in Q1. However, about 0.80% of Q2’s 2.8% increase was due to increasing inventories, which can be a double-edged sword. On one side, if inventories are being increased in anticipation of growing new orders, then it is bullish. If inventories are growing in anticipation of higher tariffs or supply-chain issues down the road (companies stockpiling ahead of any potential increases and subsequent delays), then purchasing managers are simply pulling forward future purchases, and this can lead to an economic air pocket. At this point, inventory levels for businesses and retail (ex-auto) have been ticking modestly higher, while manufacturing and wholesale inventories have been moving sideways. In our view, it's too early to worry about excessive inventory builds (second chart below). The better-than-expected GDP growth will help alleviate fears that the only way the market can move higher is if the Fed cuts.
Figure 2: Real GDP year/year growth is within the 5-year range (+/- 1 SD).
Figure 3: Inventory-to-sales ratios have recovered post-pandemic but aren’t yet deemed excessive.
We’re keeping an eye on earnings revisions for signs that earnings may fall short or exceed expectations. As you can see in the table below, for Q3, over the past four weeks, there have been 200 upward revisions, 165 downward revisions, and 123 unchanged. This is relatively positive. Note that for the full year 2024 (inclusive of what we already know occurred in the 1H), there were 175 revisions higher, 200 lower, and 119 unchanged, illustrating a bit of downward pressure. 2025 expectations are probably too early to place much weight on, but revisions show 185 up, 220 down, and 92 unchanged, indicating a downward bias.
From a sector perspective, for 2024, Communication Services, Real Estate, Information Technology, and Financials show estimates moving higher. Utilities are unchanged. The remaining sectors have negative revision ratios.
Figure 4: Earnings estimate revisions for the 2H of 2024 and 2025 have moved slightly lower over the past four weeks. This isn’t unusual.
The US economy is facing a mixed outlook, with Q2 GDP growing faster than expected, but overall growth indicators are still signaling a slight slowdown. Q2 Core PCE (the Fed’s preferred inflation measure) showed a surprise increase, likely due to one-time revisions that likely won’t alter the current soft patch for inflation. Overall, the US data is seen as generally constructive, with the personal consumption expenditure price index in the US edging up 0.1% month-over-month in June 2024. However, the annual PCE rate decreased to 2.5% from 2.6% as expected, but the annual core PCE inflation steadied at 2.6%, failing to decrease to the expected 2.5%. Despite these figures, it is expected that the Fed's stance will remain unchanged. The US economy's growth remains below potential, and employment strength is waning, which is likely to be the focus of Chair Powell's upcoming remarks.
Figure 5: The Inflation Timing model continues to reside in the “Low Inflationary Pressures” zone, though it has been moving higher. The chart below features the model calling the PCE year/year change, with the conclusion being that inflation is still in a downtrend. (We’d also note that higher inventories are relatively disinflationary for commodities and, therefore, inflation.)
Turning to a couple of indicators within the Catastrophic Stop model, we find that the Daily Sentiment Composite moved deeper into neutral territory last week, indicating that some of the froth has been purged from the overall markets. Anecdotally, Morgan Stanley observed that “Last week was the largest period of Semis selling since 2022, and investors are the most underweight the Mag7 relative to the market since 2016." If the Sentiment Composite moves to 33 or so, we would view it as potentially marking a useful support area, that saw the markets bottom in October of last year and April of this year.
Figure 6: Sentiment is approaching levels that have been constructive for equities.
Reviewing volume-adjusted Supply and Demand for the Information Technology sector, demand is still outpacing supply, though the spread has been contracting. This dovetails with last week’s equity index results. Historically, the info tech sector has outperformed the S&P 500 by 4.75 percentage points (annualized) when buyers are in control. If the spread should turn in favor of sellers (supply), we would look to reduce exposure as long as the composite model confirms the weaker technical backdrop.
Figure 7: Demand still outpacing supply for the Information Technology sector, though the spread is narrowing. If the spread holds, then one would have to label the recent tech weakness as a correction that is unlikely to develop into a deeper decline.
Figure 8: Volume-adjusted demand for the S&P 500 actually spiked higher last week as breadth improved. This is a bullish underpinning within the Catastrophic Stop model.
Lastly, the 6-month implied forward Treasury Bill rate is 4.40% versus the actual yield of 5.18% (as of 7/26), for a difference of -0.78%. This is another indicator relationship portending rate cuts, signaling a total of around 78 bps over the next six months. With the FOMC decision scheduled for Wednesday, there may be a surprise cut (low probability), but if it doesn’t happen, we expect it will occur in September (the 18th). We’ll be monitoring our overbought/oversold (OBOS) indicator should we get a ramp higher on any rate cut news for signs that a blow-off top is in play.
Figure 9: Rate cuts are on the way. This is bullish unless the accompanying statement reads, “One and done.”
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 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.
Real Gross Domestic Product (GDP) – Is an inflation-adjusted measure that reflects the value of all goods and services producted by an economy in a given year. Real GDP is expressed in base-year prices.
Core Personal Consumption Expenditures (PCE) price index – Is an economic indicator that measures inflation in the Unite dStates by tracking the prices of goods and services that consumers purchase, including food and energy costs.
MAG7 – A group of seven high-performing and influential stocks in the technology sector.
FOMC Meeting – The FOMC (Federal Open Market Committee) eight regularly scheduled meetings per year. At these meetings, the Committee reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-term goals of price stability and sustainable economic growth.
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