Day Hagan Catastrophic Stop Update November 5, 2024
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The Catastrophic Stop model declined to 60.7% from 67.9% last week. The Internal Composite is bullish, and the External Composite is neutral. The Catastrophic Stop model has moved closer to neutral, setting it up to generate a sell signal more quickly if conditions warrant.
Our U.S. Equity Model’s momentum measures, mean reversion, breadth, volatility, ETF inflows, sentiment, relative forward earnings expectations, and the U.S. dollar remain supportive. Weaker manufacturing PMI trends and valuations are headwinds. The net result supports the view that the uptrend is intact—especially with many U.S. equity markets and sectors near all-time highs. If our models shift to bearish levels (below 40% for two consecutive days), we will raise cash.
Figure 1: Catastrophic Stop Model vs. S&P 500 Total Return Index.
Equity markets are now entering a seasonally favorable time of year, even though U.S. elections will likely deliver a speed bump. Looking at the Dow Jones Industrial Average’s performance during different Presidential and Congressional Combinations since 1901, we note that a Republican President and Split Congress have historically had the lowest returns since 1901. However, that condition has only been in place 11.4% of the time, which is a relatively small sample size. A Republican President with a Republican Congress has historically been better for equities (7.3% annualized return, 22.7% of the time), as has a Democratic President with a Democratic Congress (7.0% annualized return, 33.9% of the time). Nonetheless, we take these kinds of studies with a grain of salt in that it is the policy initiatives that will most influence the financial markets, and getting a bead on what each party is actually promoting is proving elusive. At this point, the most glaring and “investable” difference would be around potential tax policy changes. Very simply, if corporate taxes are increased, stocks will suffer.
Figure 2: The range of outcomes for different Presidential and Congressional Combinations is wide. Not a useful investment tool on its own, in our view.
History shows that a “High Tax” environment does not support high valuation multiples. For example, when inflation is neutral (between 0% and 4%) and taxes are low, the S&P 500 typically traded around a 20.1x Price/Earnings ratio. However, when inflation was neutral and taxes were high, the average multiple dropped to 16.3x, which would equate to more than a 21% drop in prices from the multiple reset alone. (Source: Valens. Data from 1914-2020.)
Figure 3: Higher taxes = stock market decline.
We do note that, based on a historical, quantitative, and unemotional analysis, the monetary and fiscal policy index that we track (measuring economic liquidity) has increased, on average, during election years (tapering off toward the end of the year) and then entered a downtrend for the First and Second Presidential years. Note that even though stimulus declined, on average, during the First Presidential Year, the S&P 500 continued to move higher. It wasn’t until the 2nd Presidential Year that equities demonstrably weakened. We’ll continue to closely monitor stimulus and liquidity indicators for signs that the credit backdrop is tightening up. So far, credit conditions remain positive and the majority of global central banks are focused on more stimulative policies.
Figure 4: Even though stimulus deteriorates in the first Presidential year, equities have tended to drift higher. Bodes well for 2025.
As we head into the final leg of the election, below are a few charts illustrating the market’s backdrop. Bottom Line: The indicator evidence is neutral, neither excessively oversold nor excessively overbought. The economic and inflation outlooks remain constructive, and earnings are OK, so far.
Figure 5: According to the Economic Surprise Index, investors are underestimating economic activity. This is positive from a contrary opinion perspective.
Figure 6: Short-term sentiment measures are neutral on balance.
Figure 7: The Smart Money is bearish. Two observations: 1) This indicates that the Smart Money has cash available, and 2) the Smart Money has been bearish for most of the recent rally. The “cash available” is most important.
Figure 8: Individual investors are also leaning bearish, based on the AAII numbers.
Figure 9: 10 and 30-day TRIN reversing from overbought levels.
Figure 10: Very short-term OBOS measures (17- and 14-day stochastics) are oversold.
Figure 11: Put/Call ratios indicate that hedging is at moderate levels. This could be a problem if the market dumps—folks aren’t prepared for it and will have to play catch-up.
Figure 12: The market is “in gear” according to the High/Low Logic Index. Another “neutral” indicator.
Figure 13: Still waiting for small caps to break out of the long-term downtrend. If this were to occur, it would be a good sign that investors were becoming more risk-on.
Figure 14: Inflation is heading in the right direction, and U.S. economic activity is good. This provides a good foundation for equity gains in the longer term.
Bottom Line: Heading into the election, short-term measures are generally neutral. Our longer-term models remain supportive, with U.S. equities near all-time highs. Several major models are showing initial signs of weakness, which we’ve seen before. However, at this juncture, our models' collective message is that the uptrend is intact.
Our goal is to stay on the right side of the prevailing trend, introducing risk management when conditions deteriorate. 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 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.
Dow Jones Industrial Average – Is the aggregate dividend yield on the 30 stocks that make up the Dow Jones Industrial Average. The DJIA is one of the most widely watched market ideas in the financial markets and is considered a bellwether of the U.S. economy.
Price-to-earnings (P/E) ratio – A valuation metric that compares a company’s stock price to its earnings per share (EPS) to determine if a stock is expensive or cheap. It’s calculated by dividing the current stock price by the EPS, which is calculated by dividing the last 12 months of earnings by the weighted average shares outstanding.
TRIN - is a technical analysis indicator that compares the number of advancing and declining stocks (AD Ratio) to advancing and declining volume (AD volume). It's used to gauge overall market sentiment.
Mean Reversion – Is a trading strategy that’s based on the idea that prices will eventually return to their average or long-term mean.
PMI Index – Purchasing Managers’ Index is a survey-based economic indicator designed to provide a timely insight into business conditions.
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.
Put/Call Ratio – Is a technical indicator that measures the volume of put options traded relative to the volume of call options traded. It is a widely used tool for gauging market sentiment and predicting potential market trends.
Hedging – Is a strategy that seeks to limit or offset risk in an investment or a portfolio of investments.
Small Cap stock – Is a publicly traded company with a market capitalization – the value of its common shares calculated by multiplying the number of shares by the current stock price – of between $300 million and $2 billion.
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