Day Hagan Catastrophic Stop Update March 18, 2025
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The Catastrophic Stop model declined to 51.43% from 63.57% last week. The model’s technical indicators are now low neutral on balance due to the intermediate-term trend factor turning negative, joining the short-term trend and stock/bond relative strength factors discussed last week. Neutral readings remain in place for our breadth thrust and oversold mean reversion factors. Positive technical factors include global equity breadth and volume demand/supply. Our external factors show that the sentiment composite is bullish (currently registering extreme levels of pessimism), and high-yield and emerging market bond breadth is positive. However, our High-yield OAS factor has flipped to a negative reading (discussed below). Importantly, our models and indicators do not indicate that a recession is currently in place or imminent. Overall, the model’s indicators show that the current decline is still within the context of the longer-term secular uptrend.
Figure 1: Catastrophic Stop Model vs. S&P 500 Total Return Index. Note: Current levels are near what was observed at the low on August 5, 2024 (blue circle). A break below 40% for two consecutive days would generate a sell signal.
Credit spreads (and option-adjusted spreads) have been widening, albeit from very low levels. Typically, spreads widen when credit risk increases, or investors are seeking to reduce exposure to riskier assets like junk bonds and/or market stress emanating from concerns around economic activity. Our view is that the increase is rational, given the market backdrop and significant levels of uncertainty. However, the credit spreads we monitor are still well below their respective historical averages, meaning investors are not panicking, and financial markets continue to function normally.
Figure 2: Credit spreads are widening but remain below long-term averages.
Figure 3: OAS for U.S. IG Corporates, High Yield, Mortgage-Backed Securities, and Agencies trending higher but at the lower end of the longer-term range. Caution signal.
How oversold is the market? Based on our Oversold Mean Reversion factor, the markets are more oversold than observed on August 5, 2024, and the 2023 October lows, and on par with the levels seen at the 2022 lows. However, as we all know, oversold conditions can become even more oversold. As you look at the chart below, note that the instances of more oversold levels were accompanied by periods of actual or perceived economic weakness: 2008-2009, 2011 (interestingly, the U.S. lost its AAA rating on August 5, 2011), 2015 (China stock market crash, Black Monday [not “the” Black Monday of 1987], and taper tantrum), 2018 (tariffs and taper tantrum), and 2020 (pandemic).
Figure 4: Markets are oversold. However, if economic activity meaningfully decelerates, this indicator could move to deeper oversold levels.
GS evaluated twenty-one 10% corrections since 1980 and found that the declines provided a good opportunity (on average) as long as the markets didn’t enter a recession within the next 12 months. Interestingly, even when eventually accompanied by a recession, buying 10% corrections was marginally profitable 3, 6, and 12 months later.
Figure 5: Buying after 10% corrections has historically been a good move, assuming no recession. (via MarketEar)
Seasonality is expected to shift from a headwind to a tailwind as we enter April. Interestingly, years ending in “5” since 1885 have had the best returns, up an average of 20.7% and positive 92.3% of the time (2015 is the only year ending in 5 to be negative, returning -0.7%, source NDR).
Figure 6: Seasonal forces are turning positive in April
Short-term sentiment measures remain at excessively pessimistic levels. Historically, this has provided a tailwind.
Figure 7: Short-term sentiment measures show pessimism is rife within the markets
Two of the main economic measures we monitor are the NFIB (National Federation of Independent Business) and PMI (Purchasing Manager Index) reports. What we saw in the February NFIB Economic Trends report was that small businesses were considering slowing investment due to policy uncertainty, leading to a reduction in confidence that the economy will continue to grow. In fact, fewer respondents are expecting better business conditions in the next six months, though the aggregate levels are still above the historical average.
Figure 8: Policy uncertainty is a driver of risk-off actions and can be a problem if not addressed
The details of the NFIB survey show that current job openings, expected credit conditions, and earnings trends responses were generally more positive than the previous month. In fact, the measure of credit conditions (loan availability compared to three months ago) is nearing historically high levels.
Figure 9: Credit conditions are still supportive. Measures of business and consumer credit conditions are positive.
Turning to the PMIs, the S&P Global U.S. Manufacturing PMI increased to 52.7% in February, the second month of expansion and the highest since 2022. Output and New Orders were solid.
Figure 10: The Manufacturing PMI does not currently portend an extended economic slowdown
The U.S. Services PMI also remained in expansion territory, though the level has slipped from the December peak. S&P Global stated that new business activity slowed considerably as client demand was hampered by uncertainty related to government policy and trade tariffs, which drove export demand to fall for a second straight month. Our takeaways are 1) uncertainty can lead to more tangible market disruptions, and 2) it is likely that as uncertainty is lifted, markets will respond favorably given that long-lasting damage hasn’t already occurred.
Figure 11: The Services PMI is softening, but still in expansion territory. Watching closely.
Bottom Line: The Catastrophic Stop model continues to move toward levels setting it up for a sell signal should conditions continue to deteriorate. The tariff crosscurrents are undermining investor and corporate confidence, which can lead to real world consequences. In fact, economic growth estimates for the U.S. and rest of the world are being ratcheted down in response. Nonetheless, the quantitative appraisal of our bevy of economic indicators suggests that a major economic downturn is not currently a high probability, i.e., global economic growth is still modestly positive and expected to continue higher for the year. At this point, the model’s message is that the current downturn doesn’t rise to the level of potentially catastrophic. However, should the model move to levels triggering a sell signal, we will be quick to rebalance the portfolios in response.
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 2025 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.
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.
Purchasing Manager Indexes (PMI) – Purchasing Managers’ Index is a survey-based economic indicator designed to provide a timely insight into business conditions.
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