Day Hagan Catastrophic Stop Update September 3, 2024
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Catastrophic Stop Update
The Catastrophic Stop model held steady at 48.6%. The Internal and External composites are neutral.
Figure 1: The Catastrophic Stop model’s indicators have moved more toward neutral levels (a decline below 40% for two consecutive days generates a sell signal). This sets the model up to latch on to the next major trend. The model’s decline over the past month was primarily due to the Short-Term Trend, U.S. Stock/Bond Relative Strength, High Yield OAS, and Baltic Dry Index Factors shifting to negative levels (charts below).
Figure 2: The Short-term Trend Factor is hovering around neutral levels. A decisive move in either direction would quickly be reflected in the overall model. The short-term MA is sitting right on top of the longer-term MA.
Figure 3: The U.S. Stock/Bond Relative Strength Factor also reversed to a sell signal. The previous buy signal had been in place since November 17, 2023. When bonds evidence relative strength, it has historically been a good indication that the demand for equities is transitioning to a more risk-off or defensive posture.
Figure 4: The same holds true for our measures of credit spreads. For example, high-yield OAS could quickly reverse to bullish levels. Even though the indicator has generated a sell signal, it wouldn’t take much to reverse it. The High-yield OAS moving averages have ticked higher but are still at historically low levels. This indicates that the financial markets are behaving relatively normally. A spike higher would be concerning.
Figure 5: The Baltic Dry Index Factor shows that global economic activity (international trade) has declined slightly, but real U.S. GDP growth is positive overall. The Baltic Dry Index Factor has moved moderately lower, confirming the recent message from global PMIs.
Figure 6: Global PMIs indicate that manufacturing is still struggling while services-related businesses are holding up. The results confirm our view that economic growth is decelerating but positive.
Figure 7: Below are two charts featuring the Daily Trading Sentiment Composite. The first shows the model through the market low on August 5. The Composite had declined into the Excessive Pessimism zone. We wrote at the time, “Short-term sentiment composite is now in the excessive pessimism zone. Likely to be lower after today. If the sell-off is indeed overdone, this indicator should start showing improvement soon (i.e., a return toward optimism).”
Figure 8: Below is the updated Composite. As you can see, the model reversed nicely. However, we are closing in on levels denoting Excessive Optimism. A move above 62.5% would likely indicate short-term headwinds are in place and require a period of consolidation.
While the overall U.S. equity market was higher in August, defensive and oversold sectors led sector performance. Consumer Staples, Real Estate, Health Care, Financials, and Utilities all increased by more than 4%, while former sector leaders, including Information Technology, Communication Services, and Consumer Discretionary, returned just +1.16%, +1.23%, and -1.08%, respectively. However, it is important to note that most of the weakness in these three sectors occurred during the first five days of August (following the July 16th peak). Since the August 5th low, the Financials, Technology, Industrials, and Consumer Discretionary sectors have returned to leadership positions.
Recent economic data suggests the Federal Reserve needs to lower interest rates. The core personal consumption expenditures (PCE) price index rose by 0.2% month-over-month in July, matching market expectations. Focusing on the upcoming August jobs report, Fed Chair Jerome Powell reaffirmed the need for rate cuts due to a cooling labor market and slowing inflation. This sentiment reflects the sentiment from the last Federal Reserve meeting, where most policymakers agreed on the appropriateness of lowering the Federal funds rate.
Meanwhile, the U.S. gross domestic product (GDP) grew at an annual rate of 3.0% in the second quarter of 2024, mainly due to increased consumer spending. However, unemployment rose to 4.3% in July, the highest since October 2021, with a noticeable downward adjustment in job growth. The U.S. economy added 114K jobs in July, below expectations and reflecting a moderating labor market. Annual inflation in the U.S. slowed to 2.9% in July 2024, the lowest since March 2021.
Overall, the data shows a mixed economic picture, with a cooling labor market, slowing inflation, and declining factory activity. This has led to increased expectations of the Federal Reserve cutting rates to stimulate economic growth and stabilize market conditions, providing support for the equity uptrend. If our models shift more negatively, we will quickly respond.
Our Smart Sector Monthly Update will be out tomorrow (Wednesday). In anticipation, below are some brief thoughts around the Consumer Staples sector vs. the Information Technology sector.
Consumer Staples: As mentioned earlier, the Staples sector looked set to break out in early August; however, the leadership was short-lived. Following the market low on August 5, the sector has delivered average returns. The Composite model is now in the high-neutral zone, supported by improving momentum, better breadth (net new highs and advances/declines), stable credit ratings, valuations, and, from a contrary perspective, growing concerns around economic activity (defensive stocks do well when investors are concerned about economic growth). Cautious credit conditions, a deceleration in food sales, low short-interest ratios, and a decrease in the pricing power for food manufacturers remain headwinds. We correctly increased exposure at the beginning of August and with the September update, remain neutral.
Figure 9: Economic weakness eventually benefits defensive areas of the market. To date, the economic backdrop is still positive but decelerating. The short-term hiccup due to fears around economic activity earlier in the month boosted Staples for a short time.
Information Technology: The Composite model declined slightly with this month’s update to low-neutral levels. Indicators evaluating net new highs, relative momentum, breadth, valuations, short interest, and Emerging Asia correlations are negative. Conversely, measures of overbought/oversold conditions have not yet registered overbought reversals, and earnings revisions remain generally positive.
Last month, we noted that the top 3 holdings had shifted back to Microsoft (21.5% of the ETF’s holdings), Nvidia (19.9%), and Apple (down to just 4.89%) due to Capping requirements in the XLK ETF (to learn more about Capping, please give us a call and we’ll send you our report). Capping continues to be an important factor, with the year-to-date GICS Information Technology sector return +26.53%, while the XLK ETF return is just 14.35%. Note that on July 25, in response to the information technology sector model having moderated to a more neutral level, we took approximately 4% of combined exposure off the table by booking profits from our XLK (the Technology Select Sector SPDR Fund) and MAGS (Magnificent Seven ETF) positions. Prior to July, we were heavily invested in the sector due to positive internal and external indicators. The number of new highs was increasing, and other breadth indicators were close to signaling a buy. We suggested that it might be time for the troops to support the generals. Last month, we viewed the sector as overbought. However, at that point, a clear reversal had not happened, though a few of our short-term indicators were showing signs of exhaustion. Our model indicated that there was less support for the bullish trend, so being significantly overweight was no longer justified. We noted that the positioning for upside in the MAGS was overextended, as investors were fully committed to these stocks. With investors still quite optimistic, companies needed strong earnings performance to meet expectations, and it is becoming less certain that earnings growth would materialize. NVDA is now trading at 23.3 times forward sales (not earnings), down from 25.3 times on July 1st. Microsoft is 11.1 times (13.6x on July 1), and Apple is 8.9 times (8.4x on July 1). We are neutral.
Figure 10: The Information Technology sector OBOS indicator is back into overbought territory. A reversal below the lower bracket would generate a sell signal.
Lastly, our models are mixed with Energy in the news (Libya’s production decline and OPEC+ unsure of their next move). Here’s a brief overview for the sector:
Energy: In August 2024, energy pricing was influenced by several key factors. OPEC+ production cuts continued to impact oil prices by creating a buffer of spare capacity, adding uncertainty to the market despite fluctuations in demand. However, more recently, OPEC floated the idea of increasing production. Geopolitical tensions, including the situation in the Middle East and sanctions on Russia, contributed to price volatility due to concerns about potential disruptions to oil supplies. Efforts in Europe to diversify away from Russian gas increased global competition for liquefied natural gas, impacting natural gas and electricity prices. In the U.S., the use of the Strategic Petroleum Reserve (SPR) to manage oil prices also played a significant role, with decisions about SPR management influencing market expectations and price stability. The Composite model remains neutral, with measures of momentum, overbought/oversold, volatility, sentiment, and inventories negative. Positive supports include some breadth improvement, better valuations, and some stability in crude spot pricing. We remain with a neutral allocation.
Figure 11: The Energy sector's relative cash flow yield is reversing from lows, a positive occurrence. Should the overall model improve, we will add to the position.
Bottom Line: The quantitative, unemotional outlook confirms that economic growth is decelerating but still positive overall. Inflation pressures continue to diminish. As our indicators shift, we will adjust the portfolio accordingly, up or down.
Our goal is to stay on the right side of the prevailing trend, introducing risk management when conditions deteriorate. Currently, the uptrend remains intact. 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.
PS: Below is the updated 2024 S&P 500 Cycle Composite. Enjoy.
Figure 12: S&P 500 Cycle Composite for 2024
Disclosures
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 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 Information Technology – Comprised of those companies included in the S&P 500 that are classified as members of the GICS information technology sector.
Short-Term Trend – A market’s movement sustained over a relatively short period of time.
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.
MAG7 – A group of seven high-performing and influential stocks in the technology sector.
Option-Adjusted Spread (OAS) – Is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is then adjusted to take into account an embedded option.
Sentiment – Market sentiment is the current attitude of investors overall regarding a company, a sector, or the financial market as a whole.
Real Gross Domestic Product (GDP) – Is an inflation-adjusted measure that reflects the value of all goods and services produced by an economy in a given year. Real GDP is expressed in base-year prices.
Baltic Dry Index Factor – Is a shipping and trade index created by the London-based Baltic Exchange. It measures changes in the cost of transporting various raw materials, such as coal and steel. The Baltic Dry Index is a composite of four sub-indices that measure different sizes of dry bulk carriers or merchant ships: Capesize, Panamax, Supramax, and Handysize.
Purchasing Manager Indexes (PMI) – Is a measure of the prevailing direction of economic trends in manufacturing.
Core Personal Consumption Expenditures (PCE) price index – Is an economic indicator that measures inflation in the Unite dStates by tracking the prices of goods and services that consumers purchase, including food and energy costs.
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