Day Hagan Catastrophic Stop Update October 7, 2024
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Summary
The Catastrophic Stop model increased to 82.9% from 65.7% last week. The Internal and External Composites are bullish.
Figure 1: The Catastrophic Stop model continues to recommend a fully invested position.
The increase was primarily due to the narrowing of high-yield credit spreads (OAS), which indicates that financial markets are functioning normally, and investors aren’t expecting a major financial dislocation.
Figure 2: Declining high-yield OAS is supportive of equities.
The Catastrophic Stop model has correctly recommended a fully invested position for the entirety of 2024. In fact, as of September's close, the S&P 500 has been up for five straight months. According to NDR, this condition has typically been bullish going forward. For example, the average win streak since 1926 is seven months (range = 5 to 12 months). Looking out a year, the win rate is 84.2%, and the average return was 11.7% versus the all-period mean of 8.3%.
Figure 3: The 5-month win streak study concludes that strength begets strength.
Last week, we completed our monthly sector rebalancing, adding exposure to the Consumer Discretionary sector (now modestly overweight vs. neutral), Information Technology (neutral), and the equal-weight S&P 500 (providing more SMID exposure). We reduced Health Care (from overweight to neutral) and Consumer Staples (neutral). Below are brief model updates for the aforementioned sectors. For the full report and model updates for each sector, please visit https://dayhagan.com/research.
Consumer Discretionary Sector: The composite model improved with October’s update. Measures of trend, momentum, positive earnings surprises, and a reversal from short-term oversold conditions turned positive during the month. In response, we added exposure and are modestly overweight.
Figure 4: Earnings surprises reversed from negative levels and are now more supportive.
Information Technology Sector: The composite model has improved, but the indicators remain mixed, with the overall level squarely in the neutral zone. Measures of momentum, net new highs, long-term breadth, and sales growth are negative. Bullish supports are based on reduced market-based inflation expectations and a relatively high short-interest ratio (indicating pessimistic conditions that could reverse). We remain with a high-neutral allocation.
Figure 5: Relative breadth is still in a downtrend. However, the indicator is approaching levels where significant reversals have formed.
Health Care Sector: The composite model declined this month, and we have reduced exposure to a neutral allocation. The decline was primarily due to several technical indicators turning negative, including short-term trend, momentum, and relative downside volatility. Earnings revision breadth also reversed lower, joining the negative messages from measures of declining health care new construction and health care personal expenditures.
Figure 6: It was a nice run, but the Healthcare sector’s momentum indicator is now rolling over from an overbought extreme.
Consumer Staples Sector: The composite model declined this month, with overbought/oversold and breadth measures turning negative. This is in addition to negative readings based on prevailing credit conditions, food sales growth, relative short interest levels, and decelerating food inflation (pricing power). We modestly reduced exposure and remained neutral.
Figure 7: Relative breadth for the Consumer Staples sector indicates broader-based relative weakness.
We note that the U.S. Economic Surprise Index has moved above 0. This shows that economic releases over the past three months have met expectations. This is a positive development.
Figure 8: The Economic Surprise Index shows that investors are no longer overestimating economic releases. Expectations have been recalibrated.
Turning to the November elections, below are two charts of potential interest.
Figure 9: Historically, the monetary and fiscal policy index has risen during election years (tapering off toward the end of the year) and then entered a downtrend for the First and Second Presidential years (orange line). Note that even though stimulus declined, on average, during the First Presidential Year, the S&P 500 continued to move higher (blue line). It wasn’t until the 2nd Presidential Year that equities demonstrably weakened. We’ll be closely monitoring stimulus and liquidity indicators for signs that the credit backdrop is tightening up.
Figure 10: Looking at DJIA performance during different Presidential and Congressional Combinations, 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 11.36% of the time, which is a relatively small sample size. A Republican President with a Republican Congress has historically been better for equities. 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 promoting is proving to be elusive. At this point, the most glaring and “investable” difference would be around potential tax policy changes.
Figure 11: 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 trades around a 20.1x Price/Earnings ratio. However, if inflation is neutral and taxes are high, the average multiple dropped to 16.3x, which would equate to more than a 21% drop just to the multiple reset.
Bottom Line: Our 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.
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.
S&P 500 Consumer Discretionary – Comprises those companies included in the S&P 500 that are classified as members of the GICS consumer discretionary sector.
Credit spread – The difference between two debt securities with different credit ratings but similar maturities. It is a common way to measure how much of a premium an investor might receive for taking on more risk.
Economic Surprise Index – Represents how much economic data differs from what was expected by the market.
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