Day Hagan Catastrophic Stop Update September 17, 2024
A downloadable PDF copy of the Article:
Catastrophic Stop Update
The Catastrophic Stop model increased to 65.7% from 55.7% last week. The Internal Composite (price-related indicators) is positive, and the External Composite remains neutral.
Figure 1: The Catastrophic Stop model continues to support a fully invested position.
The model’s increase was due to the Baltic Dry Index Factor turning positive, indicating improving global trade.
Figure 2: The Baltic Dry Index tracks rates for shipping dry bulk commodities and is often considered a leading indicator of economic activity. It measures 23 different shipping routes. However, the indicator has yet to decisively break out, meaning that it could quickly reverse back to a sell signal.
Retail sales, released this morning, increased 0.1% month/month for August, better than the -0.2% forecast. This follows an upwardly revised 1.1% gain in July. This indicates that consumer spending is holding up.
Figure 3: Retail Sales trends correlate well with Home Sales trends (correlation = 0.68%). Continued consumer spending is critical to avoiding an economic slowdown.
We continue to monitor several indicator composites designed to define the probability of significant economic slowdowns. Most show the probabilities increasing, but not yet at levels that have historically been conclusive. For example, the U.S. Recession Probability Model Based on State Conditions is moving higher, but nowhere near the 50% recession-signal level.
Figure 4: The U.S. Recession Probability model assesses trends in employment, hours worked, and wages and salaries by state over the past 3 months. The model’s increase in recession probability odds is consistent with the message from the Global Recession Probability model shown last week.
Let’s keep in mind that credit conditions for businesses and consumers remain favorable. Fed rate cuts will further support lending.
Figure 5: Favorable (and improving) credit conditions are supportive. We note that credit spreads (featured last week) continue to illustrate a healthy financial backdrop.
Recent updates to the Earnings Model show some weakness starting to appear. While investors seem to be focusing on every utterance from every Fed governor, it’s earnings that have driven stock performance over time.
Figure 6: The Earnings model’s recent decline is due to the potential economic weakness indicated by the increasing number of unemployment claims. We note that measures of industrial production, Composite PMIs, the yield curve, EPS momentum over the past three months, and services activity are also weaker. Indicators calling price pressures (inflation), credit spreads, and SP500 estimate revisions (second chart below) are positive.
Figure 7: If earnings are indeed under pressure, we would expect the percentage of positive earnings revisions to start rolling over. To date, this measure is holding up well. However, weakness would, of course, be concerning.
As we approach the FOMC decision tomorrow, there is a 65% probability of a 50-bps cut versus a 35% probability of a 25-bps cut. To be clear, no one knows what the Fed will do, nor what the market reaction will be. Suffice it to say that a dovish Fed (or, alternatively, a “past peak hawkishness Fed”) is a positive underpinning.
Figure 8: Odds for a 50-bps cut have increased from 25% one month ago to 65% as of this writing.
Heading into tomorrow’s announcement, the U.S. equity sentiment backdrop is exactly neutral at 50%.
Figure 9: Equity Sentiment is neutral, as are most overbought/oversold indicators and composites.
Lastly, we remain cognizant of the market’s valuation. The S&P 500 index is priced at such a level that most things must go right. Lower policy rates will help, but any disruption, say higher taxes, a resurgence in inflation, or an exogenous event that disrupts supply chains, among other examples, would likely be met with a significant multiple reset.
Figure 10: The S&P 500’s Forward P/E is back to 21.6x. Our sector models continue to lean toward defensive areas of the market, including Utilities, Staples, and Health Care. As we all know, valuations don’t matter until they do.
All in all, the weight of the evidence is neutral. As for our sector allocations, during our rebalance at the beginning of this month, the models shifted more defensively, with Health Care, Consumer Staples, and Utilities all increasing and Information Technology retreating.
Bottom Line: The sector modeling was the first part of our risk management program to shift to more defensive positioning, effectively reducing the overall portfolio's beta. The second part of our approach to risk management would be an increase in cash, which is currently not yet supported by the weight of the evidence. However, the recent market weakness has caused the first round of short-term indicators to correctly flip negative. If the intermediate-term indicators follow suit, causing the Catastrophic Stop model to turn negative, we will reduce risk in the portfolio by increasing our cash allocation.
As we’ve discussed over the past many weeks, the quantitative, unemotional outlook confirms that economic growth is decelerating but still positive overall. However, the economic growth story is clearly under more pressure. The good news is that, from our vantage point, inflation pressures continue to diminish.
Our goal is to stay on the right side of the prevailing trend, introducing risk management when conditions deteriorate. Currently, the long-term 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.
Additional Chart of Interest
PS: Below is the current Fed Funds Futures Curve (dark blue line) to give you an idea of what’s currently priced in the market. Investors are currently forecasting Fed Funds to hit 3% in 10 months or so.
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 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.
Purchasing Manager Indexes (PMI) – Is a measure of the prevailing direction of economic trends in manufacturing.
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.
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.
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.
Yield Curve – Is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates.
Beta – Measures a portfolio’s volatility relative to its benchmark. A Beta greater than 1 suggests the portfolio has historically been more volatile than its benchmark. A Beta less than 1 suggests the portfolio has historically been less volatile than its benchmark.
Disclosure: The data and analysis contained herein are provided "as is" and without warranty of any kind, either express or implied. Day Hagan Asset Management, any of its affiliates or employees, or any third-party data provider shall not have any liability for any loss sustained by anyone who has relied on the information contained in any Day Hagan Asset Management literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. Day Hagan Asset Management accounts that Day Hagan Asset Management or its affiliated companies manage, or their respective shareholders, directors, officers, and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. Day Hagan Asset Management uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. The performance of Day Hagan Asset Management’s past recommendations and model results is not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates, or other factors.
There is no guarantee that any investment strategy will achieve its objectives, generate dividends, or avoid losses.
For more information, please contact us at:
Day Hagan Asset Management
1000 S. Tamiami Trail, Sarasota, FL 34236
Toll-Free: (800) 594-7930
Office Phone: (941) 330-1702
Websites: https://dayhagan.com or https://dhfunds.com
© 2024 Day Hagan Asset Management
