Day Hagan Catastrophic Stop Update October 29, 2024
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The Catastrophic Stop model increased to 67.9% from 62.9% last week. The Internal Composite is bullish, and the External Composite is neutral.
Figure 1: Catastrophic Stop Model vs. S&P 500 Total Return Index
There’s been a lot of press around the recent increase in U.S. Treasury yields, with the 10-year up 53 bps over the past month to 4.28%. However, for perspective, the 10-year was 4.20% three months ago, 4.67% six months ago, and 4.84% one year ago. (Also shown are mortgage rates and SOFR.)
Figure 2: Treasury Yields, Mortgage Rates, and Secured Overnight Financing Rates (SOFR)
We don’t see this as unusual. The table below shows that rates have been mixed since 1970 following the first rate cuts. For the 63-day period following the 12 instances analyzed (not including the most recent), 6 evidenced higher rates and 6 lower rates. In our view, there’s also a relationship between the eventual direction of rates and economic activity. In other words, rates continued lower when a recession occurred. Currently, we are not calling for an imminent recession.
Figure 3: 10-year Treasury Yield changes following first rate cuts
Meanwhile, the growth rate of inflation (annualized) has been moving steadily lower—though inflation is still a problem. We expect the downtrend to continue with energy prices falling, interest rates higher (doing the Fed’s job), and lower-income consumers feeling the pinch. Housing is still a wildcard, with OER (owners’ equivalent rent) statistics subject to “statistical interpretation.” Note: OER accounts for about ~25% of the total CPI, and “Shelter” accounts for ~33% (OER is part of Shelter). Food and Beverage is ~15% (food at home is ~8%, and food away from home is ~6%). Transportation is another 15% (gasoline is ~3%).
Figure 4: Consumer Price Index (CPI) – Annualized Growth Rate
Unemployment had been rising (which is disinflationary), with the unemployment rate (blue line) still above pre-pandemic levels. However, NFIB hiring plans recently ticked higher, a good omen for employment. We like to track the NFIB’s measure of hiring plans (red line, inverted scale), as it provides a useful indicator for employment trends. The correlation is a solid -0.81 (NFIB hiring plans go up, unemployment goes down). Small businesses have fewer than 500 employees, employing ~47% of the U.S. private workforce and contributing ~44% of GDP. We also note that the recent JOLTS report indicated significantly fewer job openings and a lower quit rate. While that counters the good employment narrative a bit, our view is that JOLTS is a secondary indicator that also sports a high degree of “statistical interpretation,” which is a recurring theme with government-generated (BLS) data sets. That’s why we always use a weight-of-the-evidence approach that provides broad confirmation of important trends.
Figure 5: Unemployment Rate vs. NFIB Hiring Plans
With inflation trending in the right direction and economic activity still positive, we have been more focused on earnings—given the valuation multiple of the broader market. As we’ve said, there isn't much wiggle room with the S&P 500’s Forward P/E over ~22x. The chart below illustrates the slow decline in consensus earnings estimates for the third and fourth quarters. While this is fairly normal (analysts generally overestimate earnings), there isn’t much more “wiggle room” for negative revisions.
Figure 6: Consensus Estimates Y/Y Growth for S&P 500 Operating Earnings per Share by Quarter
While the jury isn’t in yet (based on the percentage reported), the current percentage of companies with positive Q3 earnings surprises looks to be around the historical norms for each index below. This week, we’ll see results from many of the Mag 7. (The run date of the report below is 10-29-2024.)
Figure 7: Percent of Companies with Positive Earnings Surprises
At this point, earnings are generally meeting expectations. If we see signs of marked deterioration, we will look to allocate more defensively with our sector weightings.
Bottom Line: As we’ve discussed over the course of 2024, the long-term uptrend remains intact as we enter the seasonally favorable year-end period.
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.
Treasury Yield – Is the effective annual interest rate that the U.S. government pays on one of its debt obligations, expressed as a percentage.
Secured Overnight Financing Rate (SOFR) – A benchmark interest rate for dollar-denominated derivatives and loans that is replacing the London Interbank Offered Rate (LIBOR).
Owners’ Equivalent Rent (OER) – Is the amount of rent that would have to be paid in order to substitute a currently owned house as a rental property. It figures the amount of monthly rent that would be equivalent tot eh monthly expenses of owning a property (e.g. mortgage, taxes, etc.).
Consumer Price Index (CPI) – Measures the monthly change in prices paid by U.S. consumers. The Bureau of Labor Statistics (BLS) calculates the CPI as a weighted average of pcires for a basket of goods and services representative of aggregate U.S. consumer spending.
NFIB – The National Federation of Independent Business advocates on behalf of America’s small and independent business owners.
JOLTS Report – Is a monthly report from the U.S. Bureau of Labor Statistics (BLS) that provides information on the state of the job market.
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