Day Hagan Catastrophic Stop Update May 13, 2025
A downloadable PDF copy of the Article:
The Catastrophic Stop model increased to 72.73% from 70.83% last week. The model recommends that investors maintain their equity benchmark exposure.
The Breadth Thrust, Oversold Mean Reversion, Sentiment, Volume-adjusted Demand/Supply, Relative Stock/Bond Strength, High Yield OAS, High Yield Bond Breadth, and Baltic Dry Index Factors are positive. Longer-term Trend and Equity Breadth Factors are negative, though improving. The net result supports the view that a major bear market is unlikely to develop in the near term.
Technicals
Sentiment: Last week, we wrote, “Sentiment has reversed from levels illustrating extreme pessimism and is now rated neutral on a short-term basis. This implies that there is potential upside before sentiment headwinds (too much optimism) develop. A move above 70, followed by a reversal back through that level, would generate a sell signal.” This continues to be the case, though the potential upside before reaching extreme optimism levels is reduced, given last week's and yesterday’s rallies.
Figure 1: The DH Daily Market Sentiment Composite tracks trader sentiment via daily surveys, equity market breadth, put/call ratios, volatility, momentum, and high-yield bond activity.
Economic vs. Market-related Sentiment: The U.S. Economic Policy Uncertainty Index is spiking due to unpredictable tariffs, policy reversals, and the "Big Beautiful Bill." This massive bill, combining tax cuts, border security, and energy policy, raises uncertainty with tariff hikes, Medicaid cuts, and a potential $5.7 trillion debt increase, disrupting markets and eroding business confidence.
However, we note that Economic Policy Uncertainty (EPU) has diverged from Equity Market-related Economic Uncertainty. The good news is that the financial markets are more focused on the Equity Market-related index improvement. We also posit that the markets have priced in the EPU’s spike higher and that marginal improvement may provide an additional tailwind for equities and fixed income.
Figure 2: The Economic Policy Uncertainty (EPU) Index and Equity Market-related Economic Uncertainty Index differ in scope. The EPU Index measures uncertainty from policy-related events, using news coverage, tax code changes, and economic forecasts. The Equity Market-related Index focuses on equity market volatility, driven by stock price fluctuations and investor sentiment. While EPU captures broad policy impacts, the Equity Index reflects market-specific uncertainty, making them distinct in their economic implications.
Gamma: Heading into the May 16 options expiration (OPEX), the S&P 500 (SPX) gamma condition is characterized by a call-heavy environment with relatively low put open interest, suggesting a market pinned near key levels like 5800–5900. Positive gamma dominates, driven by in-the-money calls, reducing volatility but potentially fueling upward momentum if SPX stays above 5800. However, market makers may sell to hedge above 5860, adding resistance. Low put hedging and high call gamma indicate a bullish bias, but a break below 5800 could shift dynamics near term.
Figure 3: Positive gamma indications for the 5-16-2025 OPEX. Positive gamma = lower volatility. The VIX is currently below 18, confirming the lower volatility backdrop.
Breadth Thrust: As we entered May, we incorporated a Breadth Thrust composite of indicators into the Catastrophic stop model, rather than using a single indicator. Previously, we had focused on the ratio of 10-day Advances to 10-day Declines, and while the track record was good (45 out of 46 signals were positive a year later), there are additional breadth thrust measures that have historically provided value by calling different types of lows and have often moved to buy signals more quickly following significant declines.
The Breadth Thrust composite continues to use the ratio of 10-day Advances/Declines, while also adding measures calling 1) S&P 500 100-day Realized Volatility, 2) 3-day Rally Reversals, 3) the Zweig Thrust, and 4) the DeGraff Thrust indicator.
Figure 4: We’ve increased the number of indicators that can provide breadth thrust buy signals, allowing us to more accurately identify potential market lows. Below is an example of the 3-day Rally Reversal breadth thrust indicator.
Oversold Mean Reversion: We are also using a composite of indicators for the Oversold Mean Reversion Factor. We continue to focus on the S&P 500’s 10-day ROC, with the six-month z-score of -3 SD, which is used as the trigger for buy signals. Additionally, the model utilizes 1) Russell 3000 52-week New Highs minus New Lows, 2) Value Line 1-year Rate of Change, 3) McClellan Summation Index, 4) McClellan Summation Ratio (oversold buy signals only), and 5) Equity breadth using a 50-day range.
Figure 5: Oversold mean reversion indicators alert us when selling has reached panic and exhaustion levels. They identify the first steps in the bottoming process. Breadth Thrust measures typically trigger after the lows, confirming the probability that a major low is in place. When a breadth thrust occurs after our oversold mean reversion indicators have triggered a buy signal, it has historically been very bullish for longer-term returns.
Positioning: Goldman Sachs notes that the recent rally occurred after a tremendous bout of “futures liquidation by ‘other’ (asset managers, hedge funds, etc.). This stretch was rivaled by only one instance during COVID.” (via MarketEar)
Figure 6: Many institutional investors were underweight stocks heading into the rally. Thus, the chase.
The chart below is a good measure for identifying the implied equity allocation for systematic and algo strategies. As you can see, the equity allocation to target 10% volatility is 26.6%, well below average and indicative that institutional investors remain significantly underinvested (as of yesterday’s close).
Figure 7: 10% volatility targeting implied equity allocation is just 26.6%. There’s still some dry powder.
Operating Environment
Earnings: We’ve been following the chart below for the last several updates. As you can see, the trend in forward 12-month earnings has shifted higher and now appears to be tracking the non-recession earnings path. This is consistent with the announcements from several wire houses downgrading the probability of a recession in 2025. FactSet notes, “90% of the companies in the S&P 500 have reported earnings for the first quarter. Of these companies, 78% have reported actual EPS above the mean EPS estimate, which is above the 5-year average of 77% and above the 10-year average of 75%. In aggregate, earnings have exceeded estimates by 8.5%, which is below the 5-year average of 8.8% but above the 10-year average of 6.9%.”
We’re keeping in mind that analysts currently project Q2 y/y earnings growth to be the weakest of this year’s four quarters. As of May 8, quarterly operating earnings growth expectations are as follows: Q1 11.2%, Q2 4.7%, Q3 7.0%, and Q4 7.7% (source: Yardeni). Tariff concerns are playing a role in the lower expectations. Our view is that we’ve seen the high-water mark in tariffs, and gradual improvement is likely.
We’d also note that, as of this writing, Zelensky has agreed to meet with Putin this Thursday, which could also lower the temperature and volatility backdrop.
Figure 8: Equity markets generally follow earnings trends. Q2 earnings expectations are relatively low, potentially providing an upside surprise. Stay tuned.
Inflation: Inflation remains well-anchored. Our view is that the trend for inflation is lower. The 5-year breakeven inflation rate is 2.35%. The U.S. CPI report for April, released today, showed a 2.3% year-over-year increase, below the expected 2.4%. Core CPI rose 3.1%, slightly under forecasts. This softer data eased rate hike fears, boosting equities.
Figure 9: Inflation concerns abating. Absent renewed tariff rhetoric, we expect continued improvement.
Economic Activity: We continue to view economic activity as moderate, but positive. The Atlanta Fed GDPNow estimate for Q2 currently stands at 2.3%, but there’s a long way to go before the final tally. Last week, the ISM Services PMI (51.6) and the Final Services PMI (50.8) were both above 50, indicating expansion. Unemployment claims (228k) were slightly lower than expected, wholesale inventories were up less than expected, there were no major surprises from the spate of Fed speakers on Friday, and the “no change” to policy rates by the Fed didn’t overly impact markets. We are keeping an eye on lending, as the Senior Loan Officer Opinion Survey for April evidenced some tightening in lending standards for commercial and industrial lending. Nonetheless, business and consumer credit conditions are still positive.
Figure 10: This is a volatile series, but currently points to trend growth in Q2.th in Q2.
Upcoming reports we’ll be watching closely:
Wednesday: FOMC members Waller, Daly, and Jefferson speak.
Thursday: PPI (exp. +0.2 m/m), Retail Sales (exp. 0.0 m/m), Powell speaks at 8:40 am ET, Barr speaks again, housing data
Friday: More housing data, University of Michigan Consumer Sentiment/Inflation Expectations, TIC update (data showing U.S. purchases of foreign assets and foreign purchases of U.S. financial assets)
Conclusion
Several large players have been caught wrong-footed by this rally, and the “chase” is an important source of demand (not to mention near-record levels of buybacks). Near-term, our work indicates short-term overbought and excessively optimistic levels are getting closer, which has historically translated into periods of consolidation before the next move. In the long term, the weight of the evidence supports continued moderate economic activity and lower inflation pressures. Earnings expectations are relatively low (though positive), even in the face of an improving tariff and global economic backdrop.
As we mentioned last week, the U.S. dollar index bottomed on April 21. Continued dollar strength would encourage foreign investors (as well as U.S. investors) to increase exposure to U.S. asset classes, providing another source of demand.
As written last week, “At this point, the focus is on tariffs, unintended consequences, geopolitical reignition of war tensions, and the probability of recession. Since we can only guess at what tariffs will or will not be implemented and for how long (we actually do spend a lot of time on this), and geopolitical tensions are somewhat unknowable (Taiwan; will they or won’t they), we’ll be focusing on the probability of a recession. If our model moves to levels indicating the probability of a deeper-than-expected contraction, we will reduce risk accordingly.”
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.here to place that capital.
I hope you have a wonderful week,
Sincerely,
Donald L. Hagan, CFA
Chief Investment Strategist, Partner, Co-Founder
This material is for educational purposes only. Further distribution is prohibited without prior permission. Please see the information on Disclosures and Fact Sheets here: https://dhfunds.com/literature. Charts with models and return information use indices for performance testing to extend the model histories, and they should be considered hypothetical. All Rights Reserved. (© Copyright 2025 Day Hagan Asset Management.) Asset Management.
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.
Breadth Thrust – A technical indicator which determines market momentum, signaling the start of a potential new bull market.
Russell 3000 Value Index - Is a market-capitalization weighted equity index maintained by the Russell Investment Group and based on the Russell 3000 Index, which measures how U.S. stocks in the equity value segment perform by including only value stocks.
McClellan Summation Index – Is a long-term version of the McClellan Oscillator, which is a market breadth indicator based on stock advances and declines. Interpretation is similar to that of the McClellan Oscillator, except that is more suited to intermediate to major trends and related reversals. It can be calculated as the sum of all the daily values of the McClellan Oscillator.
Earnings Per Share (EPS) - is a commonly used measure of a company's profitability. It indicates how much profit each outstanding share of common stock has earned. Generally speaking, the higher a company's EPS, the more profitable it is considered to be.
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.
Producer Price Inflation (PPI) – Measures the average change over time in the prices domestic producers receive for their output. It is a measure of inflation at the wholesale level that is compiled from thousands of indexes measuring producer prices by industry and product category.
Disclosure: The data and analysis contained herein are provided "as is" and without warranty of any kind, either express or implied. Day Hagan Asset Management, any of its affiliates or employees, or any third-party data provider shall not have any liability for any loss sustained by anyone who has relied on the information contained in any Day Hagan Asset Management literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. Day Hagan Asset Management accounts that Day Hagan Asset Management or its affiliated companies manage, or their respective shareholders, directors, officers, and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. Day Hagan Asset Management uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. The performance of Day Hagan Asset Management’s past recommendations and model results is not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates, or other factors.
There is no guarantee that any investment strategy will achieve its objectives, generate dividends, or avoid losses.
For more information, please contact us at:
Day Hagan Asset Management
1000 S. Tamiami Trail, Sarasota, FL 34236
Toll-Free: (800) 594-7930
Office Phone: (941) 330-1702
Websites: https://dayhagan.com or https://dhfunds.com
© 2025 Day Hagan Asset Management
