Day Hagan Catastrophic Stop Update May 5, 2025
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The Catastrophic Stop model increased to 70.83% from 60.0% last week. The model recommends that investors maintain their equity benchmark exposure.
Positive component signals include the Breadth Thrust, Oversold Mean Reversion, Equity Breadth, Volume-adjusted Equity Demand, High-Yield OAS, and Fixed-Income Breadth Factors. The Daily Sentiment Composite has moved into the neutral zone. Given that the move began from historically extreme levels of pessimism, the improving sentiment “trend is our friend” until it reaches an optimistic extreme and reverses. The Longer-Term Trend Factor has not yet confirmed, though this is consistent with historical expectations.
As we wrote in our April 8th update (1 day after the market’s intraday low), “Why is the external component just ‘low-neutral,’ holding the model from issuing a sell signal? The model’s external indicators are designed to call the operating environment for equities by evaluating measures of economic activity, inflation, and how well the market is functioning (e.g., rate structures, market liquidity, and sentiment trends). The model is currently recognizing the market’s recent weakness (with the technical indicators turning negative) but continues to portray an investing backdrop characterized by still positive (though decelerating) economic growth, inflation heading directionally lower, and sentiment excessively pessimistic. In our parlance, this indicates that the recent decline isn’t expected to downshift into a larger bear market. It’s important to note that ‘big bear markets’ have historically been accompanied by a recession within the next 12 months, and while the Street’s probabilities are being ratcheted up, most still assign a relatively low probability. We’d also note that Friday’s (April 4) decline was essentially the result of a headline (China retaliating) and not the market breaking. In fact, end-of-day reports indicated that markets were orderly. We also all saw how the markets are likely to react should tariff negotiations reduce tensions, which we view as likely. (On Monday, April 7, markets reversed higher by 8.7% intraday due to a false rumor that the tariffs would be postponed).”
Technicals
Sentiment: 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.
Figure 1: S&P 500 Index vs. Day Hagan Daily Market Sentiment Composite
The Ned Davis Research Crowd Sentiment Poll targets a more intermediate-term time frame. It too reached significant lows and is reversing, though it has not yet moved to neutral levels.
Figure 2: S&P 500 Index vs. NDR Crowd Sentiment Poll – Transitional Mode Basis
Overbought/Oversold: Shorter-term OBOS measures argue for a breather. Below is the S&P 500’s 10-day rate of change with standard deviation brackets. At +2.23 SD, the near-term is overbought.
Figure 3: S&P 500 10-Day Rate of Change (5-Month Z-Score)
However, longer-term measures show that breadth has improved off the lows but has not yet reached major overbought levels. Net/net, a likely period of consolidation before the next trend develops.
Figure 4: Russell 3000 50-Day SMA Breadth
Positioning: Smart Money Confidence is rolling over after reaching the highest level in 18 years, which is constructive. Like the other longer-term indicators in our universe, there is a way to go before this indicator generates a sell signal. Goldman Sachs notes that equity volatility-based funds sold heavily by the April 7th low and remain significantly underinvested, while momentum-based strategies are chasing the uptrend. Both are considered sources of potential demand. Add the opening of the buyback window for most companies, and the demand/supply profile is supportive. (Note: Our volume-adjusted demand indicator has recently turned positive.)
Figure 5: Smart Money Confidence
As the market declined, equity investors increased their hedging activity to levels consistent with major market lows. The Sentimentrader Equity Hedging Index evaluates “Cash increases, the purchase of put options, the purchase of inverse ETFs and mutual funds, shorting of futures contracts, and the purchase of credit default swaps.” As you can see, historically, when investors move to highly hedged positioning, the market tends to find a bottom. And historically, it's taken time to work down those hedges.
Figure 6: Equity Hedging Index
Double bottoms and retests: 3Fourteen Research analyzed bear markets when the market retested the initial low. They concluded that “the market has retested the initial low in 13 of the past 18 bear markets (13 cases displayed in the chart below). These retests usually occur 1.5 to 4 months from the initial low and have become more common in modern times (7 of the past 10 cases). Another aspect of modern bear markets is significant retracements (e.g., during the 2022 bear, the S&P 500 retraced 60% of its initial low). Bottom Line: The market has now retraced >50% of the initial decline. This is larger than average during bottoming periods, but not unprecedented (60% in 2022).” While five of the 13 cases never retested, we’ll monitor our OBOS charts for signs that overhead resistance is building.
Figure 7: S&P 500 Major Bottoms – Double-Bottom Retests
Operating Environment
Earnings: Q1 2025 earnings season currently shows 76% of companies reporting positive EPS surprises and 62% with positive revenue surprises. The year/year earnings growth rate is currently a solid 12.8% (only 72% of S&P 500 companies have reported). We’ll chalk Q1 up as “good results.” However, there has been some discussion around Q2 2025’s expectations. FactSet noted that outside of the Utilities and Information Technology sectors, analyst estimates have been moving lower as the quarter progresses. This isn’t necessarily a new phenomenon; it is relatively standard for estimates to meander lower as a quarter advances. What is particularly interesting during this cycle, however, are the massive negative earnings revisions hitting the Energy sector. From March 31 through April 30, energy sector earnings have been revised down by -14.8%. The next worst was the Industrials sector, with a -4.7% earnings revision. We have featured the chart below, showing that earnings forecasts were trending lower at a rate that was more akin to EPS revision trends associated with those times when recessions occurred within 12 months. However, if one looks at earnings ex-energy, it appears that S&P 500 earnings are stabilizing. This is a welcome development. Should estimates once again reverse lower, it would be concerning.
Figure 8: S&P 500 Forward 12-Month Earnings Around 10% S&P 500 Correction Dates
Interest Rates/Credit Spreads: Even with the massive spike in equity market volatility, option-adjusted spreads for Agencies, MBS, U.S. IG Corporates, and U.S. High Yield held below their respective long-term averages. This indicates that markets continued to function normally (they didn’t break), which is constructive.
Figure 9: OAS on Agencies, Mortgages, Corporates, and High Yield
Rate Cut Expectations: With an FOMC meeting statement scheduled for this Wednesday, investors are not expecting a rate cut (current probability = 4.4%). There is a 29.8% probability for a rate cut on June 18th, and a 74.4% probability by the July 30 meeting. The takeaway continues to be that we expect the Fed to be a net positive given current market dynamics. The possibility of a positive surprise shouldn’t be dismissed.
Figure 10: Fed Funds Futures Yield Curve
Upcoming reports we’ll be watching closely:
Monday: Today’s Services PMIs were mixed, but our view is that economic activity continues to be moderately positive. (ISM Services PMI = 51.6, better than expected. Final Services PMI was a slight miss at 50.8%. Both are in expansion territory.)
Tuesday: The Trade Balance and 10-year bond auction
Wednesday: The FOMC results and consumer credit
Thursday: 30-year bond auction and unemployment claims (estimate = 231k)
Friday: 9 FOMC members are speaking – Williams twice. Who knows what they’ll say…
Conclusion
The Catastrophic Stop model indicates that the U.S. equity market will likely maintain levels above recent lows, though a retest cannot be entirely dismissed. Extreme oversold conditions have been relieved, but intermediate- and longer-term OBOS measures are not yet significantly overbought, indicating upside potential. Economic indicators are still constructive. Inflation remains sticky, though the overall trend continues to move toward the Fed’s desired level. Weakness in the energy complex supports disinflation. Earnings growth is constructive for most sectors (except Energy). Q2 is expected to show the lowest q/q growth rate of the year, with earnings expected to accelerate during the 2H. The U.S. dollar index has worked its way modestly higher since the April 21 low. Should the trend continue, it may encourage global investors to increase exposure to U.S. asset classes, providing another source of demand. Lastly, equity positioning among systematic and algo traders is not extended relative to the past 1- and 5-year ranges, indicating additional potential sources of demand.
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. While the probability has increased (recent consumer sentiment data has been negative; yes, we’re aware of the political underpinnings), current economic data continues to support a moderate economic growth outlook. 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.
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.
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.
OBOS Indicators – Overbought/Oversold (OBOS) index relates the difference between today’s closing price and the period’s low closing price with the trade margin of the given period.
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.
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.
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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